Impact of Climate Regulations Uncertainty on default risk of ESG Firms: Evidence from USA

Abstract

Climate change is widely recognized as a significant global concern. Climate hazards have the potential to exert inescapable impact on various economic sectors, corporations particularly financial markets. The majority of nations have made commitments to intensify their efforts in addressing the issue of climate change. Motivating by the complex dynamics of climate regulatory framework changes and ESG initiatives this study aims to examine the influence of climate regulatory uncertainty and ESG activities on default risk of firms based in USA over the time span of 2014 to 2023. The analysis incorporates Altman z-score (Meles et al., 2023) to assess firms’ default risk. The study utilized panel regression analysis with fixed effects to assess the default risk of firms. Additionally, to deal with the issues of endogeneity 2sls and two step system GMM approaches have been applied for robust results. The findings revealed that CPU has positive significant impact on firms’ default risk. However, when ESG initiatives were included the effect size of CPU has reduced, it indicates that ESG effectively provide the cushion against uncertain circumstances and risk related to the frequent changes in climate policies. This study offers useful insights about climate related risk mitigation under uncertainty for both corporations and the investment analysts.

Keywords: Climate Policy Uncertainty, Default Risk, ESG

JEL Classification: B26, C36, D53, D81, F65, G32, Q54