New Online Tool Measures Firms’ Exposure to Severe Weather Events
A Ross School of Business professor and his former PhD student have teamed up to create a groundbreaking way to measure a company’s susceptibility to extreme weather.
Essentially, the measure – which is now available online for free – uses language in firms’ annual reports to determine the extent that weather impacts their business. It was created by Venky Nagar, KPMG Professor of Accounting at Michigan Ross, and Jordan Schoenfeld, a former PhD student of Nagar’s who is now an associate professor at the University of Utah’s Eccles School of Business.
Nagar and Schoenfeld developed the new tool after two major accounting boards – the Financial Accounting Standards Board and the International Financial Reporting Standards Foundation’s International Sustainability Standards Board – publicly called for a way to measure firms’ exposure to weather, particularly in light of the rise in extreme weather events.
A forthcoming paper in the Review of Accounting Studies outlines the new tool, which the authors call “a first step toward quantifying the impact of environmental factors on financial reporting.”
In an interview, Nagar and Schoenfeld explained that past measures of weather effects tended to take broad looks at entire industries or a few firms. The new measure they developed can help show the extent that environmental factors impact the bottom line of each individual public company.
The authors compiled information from 101,352 annual reports from about 10,000 different firms covering the years 1994-2019. They concluded that analyzing the language in the annual reports can in fact create a viable measure of each firm’s exposure to extreme weather – the extent to which weather affects firm performance.
“We wanted to understand whether weather events affect an individual company, or do they affect the market as a whole? We found that even if you're holding an index fund, you can't diversify away the impact because the entire market is suffering from weather exposure,” Nagar explained.
The authors believe it’s important to make their tool publicly available for free. “Researchers and companies can go and look at the data and see which companies are exposed,” Schoenfeld said. “If you are interested in constructing stock portfolios, and you really want to avoid companies that are highly exposed to weather, you now can use the dataset to go and try to identify those companies.”
The authors also said their tool has value for regulators and policymakers considering how companies should disclose information about environmental factors.
“There is this implicit policy assumption that we don't know much about what companies are doing or how they're exposed to weather, but what we find is there's actually a wealth of information already out there on how companies are exposed,” Schoenfeld said. “That's informative for the policymaking process.”
Nagar added, “One thing policymakers could do is just use our score as opposed to requiring companies to embark on some complicated process of creating new disclosures. They could just require disclosure of our score.”