Beyond profits: An analysis of the relationship between ESG and bankruptcy risk

Abstract: ESG scores are now regarded as an established measure of sustainability performance. Concerning ESG scores, the Nordic countries, namely Denmark, Finland, Norway, and Sweden currently occupy the top four positions globally. But how does this affect the financial stability of Nordic firms and, consequently, their bankruptcy risk? The aim of this degree project was to determine how ESG scores, including both aggregated and individual pillar scores, affected Nordic listed firms’ bankruptcy risk. This was achieved by examining the relationship between ESG scores, as well as the constituent pillar scores, and a bankruptcy risk indicator. Multiple regression models were used to analyze this relationship applied on a dataset spanning the years 2016 through 2022 and including 447 different companies. The bankruptcy risk indicator employed in this study is Z-score, a metric utilized to predict bankruptcy and reflect a firm’s financial health. The results showed a significant positive relationship between the ESG-, E- and G-score and the Z-score, whereas the S-score proved insignificant. Furthermore, out of the individual pillar scores, the G-score demonstrated the largest correlation with the Z-score, highlighting its importance for financial stability. Consistent with the results of previous studies conducted and the stakeholder theory, these results provide evidence highly in favor of a negative relationship between a firm's sustainability efforts and its bankruptcy risk, indicating that companies’ financial stability can benefit from performing well in sustainability policies. This degree project seeks to challenge the previous consensus that maximizing shareholder profits is a firm’s only responsibility, by demonstrating a negative relationship between ESG scores and the risk of bankruptcy. According to the findings, companies can potentially improve their financial stability by taking into account aspects other than only maximizing earnings. This demonstrates the usefulness of stakeholder theory as the best conceptual framework for understanding sustainability in the context of risk mitigation. This is due to the fact that rather than concentrating exclusively on shareholders, the Stakeholder theory emphasizes taking into account all stakeholders influenced by a firm's operations across the entire scope of the organization. Consequently, it aligns with the implementation of ESG efforts by recognizing that firms are not necessarily negatively affected by paying attention to actions not directly linked to increased profits. While some previous research has been conducted on this subject, no study has been undertaken within the context of the Nordic countries. Therefore, this study, by examining the link between a firm’s sustainability and bankruptcy risk within the Nordic context, addresses a significant research gap.