Climate Risk and Corporate Rescues

Abstract

Climate risk poses a significant threat to economic actors across the world. Given the (systemic) nature of this risk, governments stand ready to rescue or extend relief to distressed firms in various ways. As in the case of the COVID-19 pandemic, widespread government rescues or targeted interventions in firms deemed ‘too important to fail’ are a real possibility in the case of climate-change-related impacts. While such interventions may be ex-post efficient or rather politically driven, they do not prevent deadweight losses and may create moral hazard in the sense that firms, ex ante , do not identify and/or address the climate risks they face. This ultimately means that climate change adaptation – a policy goal whose importance increases as climate change remains unmitigated – will not reach socially optimal levels. A better strategy involves adaptation policies where the relevant framework guides, incentivizes and pushes firms to build resilience to climate risks. Stress testing coupled with proactive adaptation measures that respond to revealed vulnerabilities appears to be the best option among various risk management strategies. In cases where government relief remains inevitable, there is a further need to ensure that it is fair and efficient.