ESG risks and Corporate Viability: Insights from Default Probability Term Structure Analysis

Abstract

We analyze the impact of ESG risks on the term structure of default probabilities of European non-financial corporations from 2014 to 2022. Our findings reveal that higher ESG scores decrease a company's inherent risk implicit in its probability of default, with a more pronounced effect as the time horizon for default probability increases. The relevance of ESG risks on corporate viability fluctuates over time and tends to intensify following major events related to sustainability risks, such as the Paris Agreement or the Covid-19 pandemic. Additionally, our analysis demonstrates that ESG considerations not only matter for the objective or physical probability of default but also influence the credit risk premium required by investors. This aligns with the heightened awareness and strengthening of investors' concerns towards sustainability, particularly in recent years.

Keywords: default probability, term structure, credit risk premium, ESG scores

JEL Classification: C22, C58, G12, E31, E44