Nature’s unpredictable ways can be a nuisance—the torrential rain that ruins a perfect beach day or even unexpected ice on the ground that makes everyday parking a sudden nightmare.
For small businesses, though, nature’s unpredictability can pose a more significant threat.
As climate risk increases, businesses across all industries have to allocate more of their budgets to preparing for and responding to natural disasters. Investing in risk management can help offset these costs. But, for small businesses, this can be particularly expensive and simply feel out of reach.
A recent instance of climate risk, Hurricane Harvey, caused devastating flooding and fatalities throughout areas of Texas and Louisiana. Years later, many small businesses are still trying to get back on their feet from the Category 4 hurricane.
Benjamin Collier, associate professor of risk management at the Fox School, uses data from businesses in Texas affected by Hurricane Harvey to explore the long-term effects of disasters on businesses in his new paper, “Financing Negative Shocks: Evidence from Hurricane Harvey,” published in the Social Science Research Network (SSRN).
According to Collier, “There has previously been research on how consumers or households manage [climate risks], or how they’re affected by them financially, but there has been much less work on small- and medium-sized businesses, and those businesses are crucial to the local economic recovery from these events.”
To better understand how these small- and medium-sized businesses manage climate risks, Collier utilized credit report data. By drawing random credit reports from businesses in Houston affected by the hurricane and comparing the data to a control group of businesses outside of the affected area, Collier could see how businesses were financially impacted.
“The data show whether businesses are paying their loans on time, the balance of their loans and how much is late if they’re making inquiries,” explains Collier. “These metrics are extremely useful for understanding the businesses and their obligations.”
According to Collier, an important metric to help determine the financial stress of a business is its ability to fulfill its existing financial obligations. These obligations stem beyond rent and employee payments; many businesses have credit obligations, like loan payments, to help pay for the materials and machinery that support their everyday operations.
“If a business doesn’t pay these loans on time, it can create a lot of problems for the business, such as being able to access credit in the future,” says Collier.
While these credit reports offer useful data, they lack one thing—information about how businesses were affected by Hurricane Harvey.
“We felt it was important to conduct a survey to try to complement what we were seeing in the credit reports,” explains Collier. “My co-authors and I visited the Houston area in the summer of 2018 and had a set of questions in mind.”
Collier and his co-authors met with a variety of business owners to discuss their hardships following the hurricane. After these discussions, they noticed how a business’ level of flooding often coincided with short-term delinquencies like being late or past due on repaying their financial obligations. They also found that many business owners wound up using their own funds to help facilitate the recovery of their businesses.
Collectively, the data suggest that many small businesses simply do not have risk management plans. One possibility is that these small businesses are solely focused on trying to make ends meet and do not have the resources to invest in insurance or build savings.
Collier explains, “We expect businesses that are already constrained are less likely to have risk management in place going into these events. And, as these events become more frequent and severe, they’re going to become potentially more costly to businesses—especially constrained businesses.”
So, how should businesses adequately protect themselves?
According to Collier, “Our research suggests an important priority for putting resources into risk management before these events occur. There’s a variety of things that businesses can do. Some take out funds like buying insurance and putting savings aside for rare events. It appears to us that risk management is playing an important role in the recovery process, so we would encourage businesses to heavily consider making those investments.”
Collier also encourages local and federal policymakers to consider new ways of assistance.
“The only form of national government assistance to businesses is a recovery loan, and relatively few businesses took those loans,” explains Collier. “One concern is that many businesses are not in position to take on more debt after a disaster. Many of the constraints that would prevent a business from taking another loan are also constraints that are likely going to prevent them from buying insurance in the first place or setting money aside—they just don’t have the money to do that. This is suggestive of a need for a broader set of policy tools that may be important in helping local economies recover from these events.”