The Effects of Extreme Temperature Heat Spells on Financial Performance

Abstract

We investigate the impact of extreme temperature heat spells on firms’ efficiency (sales-to-assets) and profit margin (pretax profit-to-sales) ratios. We examine how extreme temperature heat spells affect these two ratios, the first representing a demand channel and the second representing a productivity or cost channel. Heat spells with temperatures above a critical level degrade firm financial performance, mainly through the demand channel. Using the EU and the United Kingdom as our context, we find that the impact of extreme temperature heat spells on firms’ output is systematically nonlinear, resembling a hump-shaped curve. We also find that the critical temperature of a heat spell has a stronger impact on firm performance than the duration of a heat spell. For the average firm in our sample, these impacts translate into an annualized loss of sales of about 0.63 percent and a profit margin decrease of approximately 0.16 percent for a one-degree increase in heat spell temperature above a critical level. Stock prices drop by about 22 basis points in response to a similar shift in heat spell temperature. These average annualized effects include firms’ efforts to recoup business lost during heat spells. They also include firms in certain sectors and regions that may benefit from critically high heat spell temperatures.