The impact of drought on firms' borrowing costs

Abstract

This thesis has two main goals: (i) to study the debt exposure of Portuguese firms to drought risk, and (ii) to measure the impact of drought risk on the cost of debt. This topic has deserved the attention of academia, regulators, and supervisors of the financial sector, particularly in southern Europe countries, where drought risk is considered one of the main physical risks. This thesis attempts to contribute to a small body of literature that, so far, has focused exclusively on U.S. firms. To do so, we apply a set of firm-level panel regressions to a sample of 12,512 firms operating in water-intensive industries located in Portugal, between 2007 and 2019. To proxy for drought risk, we use the Palmer Drought Severity Index (PDSI). Our results suggest that approximately 4.1 billion euros of debt was exposed to drought annually in the years of more intense drought, particularly in the agriculture and forestry industries. Additionally, we find that PDSI (inverse drought risk) has a negative and statistically significant impact on the cost of debt, which is driven by micro firms and firms operating in the agricultural industry. Interestingly, we find that the effect of drought risk on cost of debt is particularly strong for fragile firms (i.e., operating in the lowest quartile of profitability and solvency). Our results are robust to changes in the sample related to the period of analysis, firm location, and dependent variable.

Date of Award	26 Mar 2024
Original language	English
Awarding Institution	Universidade Católica Portuguesa
Supervisor	Bernardo de Vasconcelos e Sousa Paula Marques (Supervisor)