Green Grades and Financial Shades: The ESG Influence on Default Risk

Abstract

This paper investigates the relationship between ESG scores and Default Probability (DP) for European firms in the STOXX Europe 600 index. We model this relationship using the Altman Z-Score and Ohlson O-Score as proxies for DP in regression analysis, while controlling for leverage, volatility, and size. The findings of this study show that higher ESG scores are associated with a higher DP for the Altman Z-Score, but with a lower DP when using the Ohlson O-Score. This discordant outcome highlights the sensitivity of results to the choice of DP proxy. The conclusion is that, even though the ESG factors can influence financial stability, their effect on default risk is minimal; hence, ESG is not the primary driver of default risk. Keywords: ESG Scores, Probability of Default, Altman Z-Score, Ohlson O-Score, Financial Stability, Environmental Performance, Social Responsibility, Corporate Governance, STOXX Europe 600, Sustainable Finance, Risk Management, Fixed Effects Model, Random Effects Model, Default Risk, Credit Risk.