Climate risks undermine investment efficiency in Global South firms

Emerging economies with high climate vulnerability, including the Philippines, Bangladesh, and Pakistan, were found to be among the hardest hit. For firms in these countries, capital-intensive investments became riskier, leading managers to scale back expansion and prioritize liquidity. The analysis demonstrates that climate shocks do not merely represent environmental risks but also serve as a structural drag on corporate financial decision-making in vulnerable economies.

Firms in emerging economies are being forced to alter their financial behavior as climate shocks increasingly disrupt investment efficiency and long-term growth strategies. A new study provides evidence that climate events impose tangible economic costs on companies. The paper, titled Economic Costs of Climate Shocks for Firms in Emerging Economies, was published in Tourism Economics (2025).

The research examines the tourism and hospitality (T&H) sector across 43 emerging economies using more than 8,700 firm-year observations spanning 2007 to 2019. It reveals that exposure to climate shocks directly reduces firms' investment efficiency and forces them into adopting short-term survival strategies that may weaken their long-term competitiveness.

How do climate shocks affect firms' investment efficiency?

The study identifies a clear and consistent relationship between physical climate shocks and declining investment efficiency. Firms facing extreme weather events or long-term climate volatility were more likely to suffer disruptions in capital allocation, resulting in under- or over-investment in projects. This inefficiency translates into higher costs, weaker profitability, and reduced ability to plan for growth.

Emerging economies with high climate vulnerability, including the Philippines, Bangladesh, and Pakistan, were found to be among the hardest hit. For firms in these countries, capital-intensive investments became riskier, leading managers to scale back expansion and prioritize liquidity. The analysis demonstrates that climate shocks do not merely represent environmental risks but also serve as a structural drag on corporate financial decision-making in vulnerable economies.

By connecting climate risk with firm-level financial outcomes, the study offers robust evidence that climate shocks can have lasting implications beyond immediate operational damage. Investment inefficiency reduces the ability of companies to maintain competitiveness, creating ripple effects across the wider economy.

What strategies are firms adopting to cope with climate shocks?

The study shows that companies in emerging markets are responding conservatively, reshaping their financial policies to prioritize resilience over growth. Firms increasingly reduce dividend payouts, retain more earnings, and depend on short-term financing tools rather than committing to long-term debt obligations. These strategies allow businesses to maintain liquidity and buffer against sudden shocks, but they also limit access to capital that could otherwise drive expansion and innovation.

This conservative approach represents a trade-off: in the short term, firms are safer from insolvency and sudden disruptions, yet in the long run they risk stagnation and reduced competitiveness. Tourism and hospitality companies, in particular, rely heavily on long-term infrastructure investment, meaning that hesitation to commit to capital projects may weaken their future market position.

The study makes clear that climate shocks are not just natural disasters but economic events that fundamentally reshape corporate financial behavior. By highlighting the mechanisms through which firms adjust, dividend retention, reduced leverage, and reliance on short-term credit, the authors demonstrate how climate risk filters directly into boardroom decision-making.

What are the policy and economic implications?

If climate shocks systematically erode investment efficiency, they threaten not only individual firms but also broader economic development and resilience. The authors argue that without external support, emerging market firms will continue prioritizing survival over growth, perpetuating a cycle of conservative strategies that limit capital formation.

To address this, the study calls for sustainable finance mechanisms tailored to climate-exposed sectors. This includes better risk-transfer tools, such as climate insurance, and stronger institutional frameworks to encourage long-term investment despite climate uncertainty. Improved access to green financing and climate-linked credit instruments could provide firms with the confidence to pursue expansion while maintaining resilience.

The authors also call attention to the role of governments in facilitating adaptation. Public-private partnerships, targeted subsidies, and infrastructure investments designed to mitigate the impact of extreme climate events can help firms recover efficiency in capital allocation. In addition, the integration of climate risk into corporate governance frameworks can ensure that firms not only survive shocks but also adapt strategically to the realities of a warming world.

To sum up, while firms are adapting through cautious strategies, these measures are insufficient for long-term sustainability. Without targeted policy intervention and the creation of climate-resilient financial instruments, emerging economies risk facing a prolonged cycle of reduced competitiveness and constrained growth.