When Nature Hits the Bottom Line: Transition Biodiversity Risk and Corporate Creditworthiness

ABSTRACT This paper investigates the effect of biodiversity risk on corporate credit risk. Using textual‐based measures of biodiversity risk, we find that firms exposed to biodiversity transition risk exhibit shorter distances‐to‐default, implying greater credit risk, compared to non‐exposed firms. In contrast, we find no significant relationship between physical biodiversity risk and distance‐to‐default. We attribute the observed link between transition risk and credit risk to a risk‐perception channel: Transition risk raises investors' perception of firm exposure, which depresses market valuations and weakens firms' capacity to meet debt obligations. To mitigate transition biodiversity risk, we propose two adapting strategies: (i) increasing cash holdings and (ii) promoting product innovation. Overall, our findings indicate that transition biodiversity risk lowers firms' creditworthiness, but strategic adaptation can enhance firms' resilience to its unfavourable effects.