Twin threats: The compound effect of transition and physical climate risks on firms' credit ratings

Examining the effects of climate risks on credit ratings, we find that the adverse impact of transition risk is greater for firms that are also exposed to higher physical risk. We exploit the first Trump administration's withdrawal from the Paris Agreement as a shock and show that, following the withdrawal announcement, high-emitting U.S. firms improve credit ratings by more than low-emitting U.S. firms and non-U.S. counterparts. This improvement is also larger for firms with greater exposure to physical risk. While firms' environmental and green activities alleviate the effect of transition risk on credit ratings, their climate-adaptation efforts affect the role of physical risk. Our results shed light on the compound effect of joint exposures to twin climate risks that amplify a firm's financial distress and default risk.