Binghamton University
10/17/2024 | Press release | Distributed by Public on 10/17/2024 04:16
Why should companies care about biodiversity? Binghamton student’s new study shows the financial impact
Biodiversity is the variety of living species - plants, animals and microorganisms - that form ecosystems and support essential functions such as pollination, water purification and climate regulation. These services are valued at trillions of dollars globally, with the U.S. agricultural sector alone benefiting from over $200 billion in pollination by bees.
When biodiversity is lost, the impact is irreversible, and ecosystems can't provide critical services. But how could this affect a company's financial well-being?
In their award-winning research, Binghamton University School of Management doctoral student Sevgi Soylemezgil and Zurack Associate Professor of Finance and Economics Cihan Uzmanoglu tackled that question by exploring how a firm's exposure to biodiversity risk and its cost of borrowing are connected.
The study found firms with higher biodiversity risk exposure face higher borrowing costs, especially for long-term borrowing. This effect is more pronounced for firms that mention biodiversity regulation in their financial statements. As a result, mitigating biodiversity risk exposure could help companies lower their borrowing costs.
"We focused on the corporate bond market because it's a good way to observe firms' cost of borrowing," Soylemezgil said of the study, her first academic paper. "We found that firms with higher biodiversity risk exposures have a higher cost of borrowing in the corporate bond market, particularly in their long-term bonds."
The study earned the 2024 Hakan Orbay Research Award for PhD Students, which supports doctoral candidates undertaking high-quality original research in finance and financial economics. Soylemezgil will present her study at a ceremony later this year in Istanbul, where the award will be handed out.
Biodiversity loss disrupts supply chains, increases operational costs and subjects firms to new regulations as governments aim to protect ecosystems. These challenges, collectively referred to as biodiversity risk, pose direct and indirect economic threats to businesses.
"Environmental scientists have long pointed to the risks of biodiversity loss," Uzmanoglu said. "Our findings show that creditors do care about these risks because firms with greater biodiversity risk exposure are penalized by paying higher interest on their bonds."
Building a connection
The study focused on 1,360 firms that contributed more than $1 million in monthly secondary market yield spreads between 2002 and 2022 to determine whether creditors recognize the importance of biodiversity risk and penalize firms with greater exposure to it.
During the research, Soylemezgil comprehensively measured a firm's biodiversity risk exposure. She found this new measure was higher for firms with physical assets in biodiversity-rich areas, whose operations depend on nature-related inputs, and those that generate more revenue from business activities contributing to deforestation. It also increased after events that raised biodiversity awareness and regulation.
Next, Soylemezgil studied the influence of a firm's biodiversity risk exposure on its cost of borrowing. She found that a one-standard-deviation increase in a firm's biodiversity risk exposure was associated with a 3% increase in the yield spreads of its long-term bonds.
Soylemezgil said this finding suggests investors consider biodiversity risk to be a significant factor in pricing long-term corporate bonds, which is consistent with biodiversity risk being long-run in nature.
"We began this research without expecting significant results because we weren't sure if investors even cared about this," Soylemezgil said. "But what we found is that investors do care - mainly when it comes to long-term bonds. Since biodiversity tends to remain stable in the short term unless a major catastrophic event occurs, investors seem to focus on its long-term risks, which explains why it is the longer-term bonds that are affected."
How to address biodiversity loss
The study also showed that short-term borrowing costs increased following the United Nations Biodiversity Conference (COP15) in 2022, elevating biodiversity-related awareness and regulatory risks.
Uzmanoglu added that firms that implement biodiversity initiatives tend to already be highly sensitive to biodiversity, and those initiatives don't appear to mitigate their existing biodiversity risk exposure.
And unlike climate regulations, biodiversity regulations could be ineffective in preventing biodiversity loss. This is because regulators cannot use a measure equivalent to carbon emissions to identify and tax firms contributing to biodiversity loss.
"It's like you're trying to prevent overfishing, but you don't know who is overfishing," Uzmanoglu said, "so, the fact that creditors take this into account and increase the cost of borrowing of those firms that potentially contribute to biodiversity loss actually indicates that there could be a market-based mechanism in addressing biodiversity loss."