Why should companies care about biodiversity? 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 worldwide, with the U.S. agricultural sector alone benefiting from bee pollination worth over $200 billion.

When biodiversity is lost, the impacts are irreversible and ecosystems can no longer provide important services. But what impact could this have on a company's financial well-being?

In their award-winning research, Binghamton University School of Management graduate student Sevgi Soylemezgil and Zurack Associate Professor of Finance and Economics Cihan Uzmanoglu explored this question by examining how a company's exposure to biodiversity risks and its borrowing costs are related.

The study found that companies with higher biodiversity risk face higher borrowing costs, especially for long-term loans. This effect is more pronounced for companies that mention biodiversity regulation in their financial reports. As a result, reducing biodiversity risk could help companies reduce their borrowing costs.

“We focused on the corporate bond market because it is a good way to observe corporate borrowing costs,” Soylemezgil said of the study, her first academic paper. “We found that companies with higher biodiversity risk have higher borrowing costs in the corporate bond market, particularly for their long-term bonds.”

The study was awarded the Hakan Orbay Research Award for PhD Students 2024, which supports doctoral students in conducting high-quality original research in the fields of finance and financial economics. Soylemezgil will present her study later this year at a ceremony in Istanbul, where the prize will also be presented.

Biodiversity loss is disrupting supply chains, increasing operating costs and subjecting companies to new regulations as governments seek to protect ecosystems. These challenges, collectively referred to as biodiversity risk, pose direct and indirect economic threats to companies.

“Environmental scientists have long pointed out the risks of biodiversity loss,” Uzmanoglu said. “Our results show that creditors care about these risks, as companies with higher biodiversity risk are penalized by paying higher interest on their bonds.”

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The study focused on 1,360 companies that contributed more than $1 million in monthly secondary market return spreads between 2002 and 2022 to determine whether creditors recognize the importance of biodiversity risk and penalize companies that are more exposed to that risk.

During the research, Soylemezgil comprehensively measured a company's biodiversity risk exposure. She noted that this new metric is higher for companies with physical assets in areas of high biodiversity, whose operations depend on natural influences, and for companies that derive more revenue from business activities that contribute to deforestation. It also increased following events that raised awareness of biodiversity and regulation.

Next, Soylemezgil examined the impact of a company's biodiversity risk exposure on its borrowing costs. It found that a one standard deviation increase in a company's biodiversity risk was associated with a 3% increase in the yield spreads of its long-term bonds.

Soylemezgil said this finding suggests that investors view biodiversity risk as a significant factor in pricing long-term corporate bonds, which is consistent with the fact that biodiversity risk is long-term in nature.

“We started this investigation without expecting any significant results because we were not sure whether investors would even care,” Soylemezgil said. “But we found that investors do care about it – especially when it comes to long-term bonds. Since biodiversity tends to remain stable in the short term, barring a major catastrophe, investors appear to be focused on their long-term risks, which explains why the longer-term bonds are affected.”

How to counteract the loss of biological diversity

The study also showed that short-term borrowing costs increased following the United Nations Conference on Biodiversity (COP15) in 2022, increasing awareness of biodiversity and regulatory risks.

Uzmanoglu added that companies implementing biodiversity initiatives are usually already very sensitive to biodiversity and that these initiatives do not appear to reduce their existing biodiversity risk.

And unlike climate regulations, biodiversity regulations may be ineffective in preventing biodiversity loss. This is because regulators cannot use a measure equivalent to carbon emissions to identify and tax companies that contribute to biodiversity loss.

“It's like preventing overfishing, but you don't know who is overfishing,” said Uzmanoglu, “so the fact that creditors take this into account and increase the cost of credit to those companies that may contribute to biodiversity.” The loss actually shows “suggests that there could be a market-based mechanism to address biodiversity loss.”