How Does Corporate Culture Impact the Relationship Between Environmental, Social, and Governance (ESG) Performance and Default Risk? International Evidence

1. Introduction

This study explores the relationship between ESG (Environmental, Social, and Governance) performance and corporate default risk, with a focus on the moderating role played by corporate culture in an international context. ESG has gained prominence in sustainable investing, but its connection to default risk is still underexplored. This research builds on prior findings that link high ESG scores with improved financial performance, and extends the analysis using a sample of 4,524 firms from 25 countries, encompassing both developed and emerging markets.

The study pursues three main objectives: confirming the negative association between ESG and default risk, examining corporate culture’s direct influence on default risk, and evaluating corporate culture as a moderator in the ESG-default risk relationship. As additional analysis it also considers firm life cycle stage, industry pollution levels, and national regulatory enforcement as additional factors.

Using Merton’s distance-to-default (DTD) to measure default risk, the findings show a positive link between ESG performance—particularly the Environmental and Social pillars—and reduced default risk. Corporate culture, measured through the framework by [1], is shown to be positively related to lower default risk. Moreover, in firms with strong corporate culture, ESG’s effectiveness in lowering default risk is amplified.

This study uses the resource-based theory (RBT) to argue that ESG disclosure reduces a company’s default risk by acting as a strategic resource [2,3]. Corporate culture can significantly reduce default risk by acting as an inimitable and valuable strategic resource. Rather than just being an intangible concept, culture is a core capability that enables the firm to manage internal risks and build a sustainable financial position that makes it more resilient to external shocks [4]. Firms with superior dynamic capabilities—the ability to adapt and integrate internal resources—can leverage ESG practices and corporate culture to manage financial risk [5]. Firms use ESG to build a sustainable advantage. This proactive approach turns ESG from a liability into an asset. This strategic management of ESG and corporate culture lowers default risk through three main channels: 1) Enhanced profitability: ESG disclosure boosts brand value and customer satisfaction, which increases sales and secures a consistent stream of revenue. Under a strong corporate culture, customer loyalty acts as a form of moral capital, ensuring stable cash flows and reducing a firm’s financial distress [6]. 2) Lower Cost of Capital: By making ESG information public, a firm reduces information asymmetry. This transparency builds trust with investors and lenders, making debt capital more accessible and less expensive [7]. 3) Reduced Performance Variability: The stability gained from loyal customers and trusted investors makes a firm more resilient to negative events, resulting in less volatile financial performance a sustainable advantage [8].

As additional analysis, the study reveals that mature firms—typically more resource-rich—benefit more from ESG in mitigating risk than younger firms. In polluting industries, only the Environmental pillar shows a significant positive effect on reducing default risk, and this effect strengthens with a strong internal culture. Governance scores, however, do not show a consistent impact. Finally, in countries with weaker enforcement systems, corporate culture becomes even more vital. It not only reduces default risk on its own but also enhances the protective influence of ESG strategies.

Overall, the study highlights the crucial role of corporate culture in maximizing the benefits of ESG initiatives, particularly in contexts of high environmental risk or weak institutional oversight.

This study provides at least five contributions to the literature. Firstly, this article studies the association between default risk and ESG for a large international sample of companies. Secondly, this is a seminal international empirical work which explores the moderating effect played by corporate culture on ESG and its corresponding impact on firm default risk. Thirdly, this research also includes the life cycle of the firms as moderating variable for the relation between ESG performance and default risk, to expand prior empirical results reported primarily for US firms [3]. Fourthly, this investigation also analyzes the potential moderating effect of polluting industries on the association between ESG performance and default risk. Actually, [9] for a USA sample of firms report that stronger corporate culture is positively associated with environmental performance. Our study includes firms from 35 different countries and explores not only the role played of firm culture on the environmental performance. Finally, this study considers the degree of enforcement in each country and its impact on the association between ESG performance and default risk.

This research assesses default risk using Merton’s distance-to-default (DTD) proxy. A higher DTD indicates a lower default risk for the firm. The findings reveal a positive and statistically significant association between ESG scores and DTD, suggesting that higher ESG scores are associated with a lower default risk for the firm. This result is also validated for two pillars of ESG (Environmental and Social). The relationship between corporate culture (C.Culture) and DTD is positive. Once $C.Culture$ is employed as moderator variable, it is confirmed that at high levels of $C.Culture$, the $ESG$ is positively associated with DTD, contributing to reduce the default risk. Furthermore, technology- and people-oriented corporate culture help to explain the positive moderating effect.

It is also shown that mature firms exhibit a higher DTD and when this variable is used as a moderator factor, for mature firms the relation between ESG and DTD becomes higher, which is not the case for younger firms. Similar results are obtained when polluting industries are included in the analysis. For polluted industries with strong corporate culture this study reports a positive relationship between ESG-E and DTD. This result is also significant when the general ESG score is employed, but not for the other two pillars (Social and Governance).

Our results have significant implications for both managers and regulators. Managers should integrate sustainability strategies with their corporate culture to strengthen risk management by considering both internal and external factors. This approach requires understanding that corporate strategies must address not only technology but also human-centric approaches, as noted by [10]. Furthermore, managers must set the “tone from the top” by clearly communicating the company’s ESG strategies across the organization and developing incentives to motivate employees to reinforce these cultural values. For regulators, our findings offer a deeper understanding of how the interplay between corporate culture and ESG initiatives influences a company’s default risk. This suggests that regulations on the content of sustainability disclosures could increase their informativeness and help reduce corporate financial distress.

The rest of the paper is structured as follows: Section 2 reviews the literature and proposes the hypotheses. The sample and the methology are presented in Section 3. Section 4 reports the empirical results. Finally, Section 5 summarizes the conclusions, limitations, and implications of the study for future research.

2. Literature Review

2.1. ESG Performance and Risk of Default

Firm risk can be influenced by ESG performance in two distinct manners [11]. The first, known as risk mitigation, explores the association between socially responsible investment and risk, reporting an inverse relationship between both variables. The second approach is known as overinvestment [12] and it is based on agency theory. In contrast, the risk mitigation theory is rooted in risk management and leverage, both stakeholder theory and the value of moral capital [13,14]. This theory elucidates how organizations enhance their resilience to shocks by lowering the likelihood of adverse events.. The second approach suggests that managers may increase the company’s socially responsible performance to project an image of social commitment, thereby enhancing visibility, reputation, and public image [15]. These two perspectives offer conflicting predictions [16].

In terms of empirical evidence, [3] find that for non-financial firms in the USA, ESG performance is positively associated with Merton’s distance-to-default and negatively related to CDS spreads, implying that companies with higher ESG scores generally face lower default risk. A related study in the USA by [17] converts Standard & Poor’s credit ratings into default probabilities and finds that firms with stronger ESG performance have a lower likelihood of default. Furthermore, [18] observe that for Chinese firms, higher ESG scores help reduce default risk. In Europe, [19] identify a negative relationship between green innovation and firm default risk, with this effect being more pronounced in countries with market orientation. [20] report a similar negative relationship between CSR practices and Z-scores in Korea. More recently, [21] investigate the link between ESG scores and default risk for the 500 largest family-owned firms worldwide, finding that higher ESG scores are associated with a lower risk of default. Another perspective proposes a positive link between ESG and risk-taking, explained by managerial opportunism theory [22]. Managers, driven by short-term profit goals, might underinvest in ESG (corporate social performance, CSP) during periods of low default risk (high corporate financial performance, CFP) to maintain higher cash reserves and mitigate the main shareholders’ risk. Conversely, when faced with high default risk, managers are likely to overinvest in ESG initiatives to justify poor performance outcomes.

The literature on firm risk includes studies on total firm risk [23,24], systematic and non-systematic risks [25,26], and default risk [27]. However, the findings in this area are inconsistent.

The arguments and the empirical evidence make more probable a negative impact of ESG performance on the firm default risk. Therefore, the first hypothesis is as follows:

Hypothesis 1 (H1). 

ESG performance and higher distance-to-default are positively related which translates into a lower default risk. 

2.2. Corporate Culture

Corporate culture embodies the collective beliefs, values, attitudes, behaviors, and practices that define an organization. It shapes the way employees think, act, make decisions, and approach their work, influencing interactions and overall organizational dynamics. [28] Corporate culture can be manifested through a company’s mission statement, policies, workplace environment, communication style, and even dress code. It significantly influences the organization’s identity, impacting employee satisfaction, productivity, and overall performance [29,30]. Therefore, culture-centric informal institutions emphasize awareness and discipline, potentially leading to a more stable and profound impact on ESG performance [31]. Addressing this matter from a cultural perspective signifies a shift from [31,32] “external coercion” to “voluntary commitment.” This gradual transition generates the optimal path for ESG practices and reduces the firm’s default risk.

While most existing research has concentrated on formal institutional variables, the rise of behavioral finance has underscored the importance of informal institutions—such as culture, customs and religion—in influencing businesses [33,34,35,36]. Despite this recognition, there has been limited academic inquiry into how these informal factors affect corporate default risk. In particular, the concept of “integrity” plays a crucial ethical role in linking Confucian culture to corporate debt default risk, as explored in some studies [37,38,39,40].

Corporate culture represents a valuable, yet intangible asset, that exerts a long-term, dynamic impact on firms, with its short-term and long-term effects varying significantly [31,32]. Researchers frequently employ questionnaire surveys or case analyses in their studies. Although case studies provide in-depth insights into the development patterns of corporate culture, their scope remains restricted.

They frequently overlook the broad applicability of their conclusions and do not provide long-term monitoring of implementation outcomes.

Based on the theoretical arguments and the extant limited empirical results, we suggest the following hypotheses:

Hypothesis 2 (H2). 

Companies with stronger corporate culture exhibit lower default risk. 

Hypothesis 3 (H3). 

Corporate culture has a negative moderating impact on the association between ESG score and default risk. 

2.3. Life Cycle

This study highlights how a firm’s position in its life cycle significantly influences its financial stability, particularly in relation to default risk and the strategic use of ESG (Environmental, Social, and Governance) disclosures. In early stages, firms experience heightened information asymmetry, making external financing costly and creating financial constraints [41]. Signaling theory suggests that disclosing ESG efforts can positively influence stakeholder perceptions, but its effectiveness—and cost—varies depending on the firm’s maturity [42].

Early-stage firms often lack liquidity and face elevated capital costs, limiting their competitiveness [43,44]. While ESG disclosures might elicit favorable stakeholder reactions [45], the high signaling costs in these phases can outweigh the benefits. Moreover, excessive ESG signaling may introduce volatility due to diminishing returns [46], especially if firms overextend disclosures.

The life cycle hypothesis [47] posits that as firms mature, they undergo systematic shifts in their financial, operational, and strategic behaviors. Mature firms tend to possess better management skills, technical expertise, and financial planning capabilities, making them more resilient to financial distress [48]. These firms can better leverage ESG signals as they have more resources and market credibility.

However, mature companies also face strategic dilemmas regarding resource allocation. Even with positive NPV projects, they must balance between debt repayment, shareholder returns, or risk overinvesting in low-return ventures [49].

In essence, the firm’s stage of development shapes how ESG strategies are perceived and their impact on financial health. Early-stage firms are more vulnerable to default, while mature firms benefit from stability—but must still navigate complex investment decisions to preserve that advantage.

Since the ESG score signals to the market, a higher ESG score leads the market to perceive the firm as higher quality, translating to a lower default risk. Considering the arguments and empirical results presented above, we state that:

Hypothesis 4 (H4). 

Mature firms exhibit a negative moderating effect of corporate culture on the association between ESG and default risk. 

Hypothesis 5 (H5). 

Younger firms show a lower sensitivity of the moderating impact of corporate culture on the association between ESG and default risk, compare to the mature firms. 

2.4. Additional Analysis

2.4.1. Heavy Polluting Industry

[50] contend that the exposure of a firm to carbon risk affects its default risk by creating uncertainty in both current and future cash flows. Consequently, a firm with greater carbon risk exposure is likely to face a higher default risk. [51] show, for a sample of Chinese listed firms, a positive association between heavy-polluting firms and default risk.

Investing in ESG influences the firm’s value and consequently affects the firm’s default risk. [52] provide evidence that ESG scores in polluting industries are perceived as maximizing firm value, thereby reducing default risk. Conversely, [53] observe that the impact of ESG on long-term debt is more pronounced for firms in polluting industries than for those in less polluting sectors. [54] report that adopting ESG systems significantly enhances the financial performance of enterprises in environmentally impactful industries. Environmental protection investments improve resource utilization efficiency, while social responsibility initiatives increase employee productivity and customer loyalty. Additionally, robust corporate governance strengthens management structures and decision-making processes. Therefore, it is expected for firms operating in highly polluting industries to exhibit a negative moderating effect of corporate culture on the relationship between ESG performance and default risk.

2.4.2. Countries with Strong Enforcement

Enforcement refers to the act of compelling compliance with laws, regulations, or directives. It ensures adherence to established standards and, if necessary, imposes corrective or punitive measures. Carried out by government agencies, regulatory authorities, or legal institutions, enforcement is critical for maintaining order and accountability across sectors. Among the most recognized indicators of enforcement is the Worldwide Governance Indicator (WGI) developed by the World Bank. This index measures enforcement quality across six dimensions: voice and accountability, political stability, government effectiveness, regulatory quality, rule of law, and control of corruption.

In the context of accounting and disclosure, enforcement plays a vital role. [55] identified a positive relationship between firm-level disclosure and forecast accuracy, suggesting that enforcement motivates managers to comply with established financial reporting standards. [56] found that firms in countries with stronger legal enforcement engage in less earnings management. [57] extended this work by showing that corporate social responsibility (CSR) disclosures are more positively linked to firm performance in countries with strong stakeholder-oriented institutional frameworks. These findings suggest that enforcement—shaped by legal, institutional, and cultural factors—supports transparency and reduces information asymmetry.

Despite the extensive literature on enforcement and accounting practices, there is a noticeable gap in studies connecting firm-level default risk with broader enforcement indicators like the WGI. However, theoretical and empirical research implies that stronger enforcement can reduce default risk by improving creditor protections. For instance, effective enforcement of debt contracts enhances the likelihood that creditors will recover loans in the event of default [58]. [59] also finds that enforcement mechanisms encourage firms to adhere to repayment obligations, reducing the likelihood of financial distress.

Enforcement—particularly when costly or limited—has implications at the contracting stage. According to [60], if lenders anticipate difficulties in enforcing contracts later, they factor this into lending terms from the beginning. In such environments, enforcement quality affects debt structures, leading lenders to demand higher interest rates or tighter loan covenants.

Poor enforcement environments harm lenders by reducing recovery rates, prolonging insolvency resolution, and weakening post-default bargaining power [61,62,63,64]. They may also facilitate opportunistic behavior, such as strategic default—where borrowers choose not to repay despite having the capacity to do so [65,66]. This further elevates lender risk and threatens the sustainability of financial systems.

To mitigate risk in these environments, banks may impose stricter lending conditions: higher interest rates, greater collateral requirements, and more restrictive covenants. While such measures increase protection, they also raise borrowing costs and could limit access to capital for lower-risk borrowers. Alternatively, banks might tighten borrower selection instead of raising rates—choosing to lend only to low-risk firms [67]. In that scenario, the credit pool becomes more selective and the observed default rate may appear lower, despite high overall credit risk.

Interestingly, strict enforcement does not always lead to higher recovery rates. [58] show that over-enforcement can result in underinvestment and encourage risk-shifting behavior due to conflicts between creditors and borrowers. In such cases, imperfect enforcement may allow greater investment flexibility and reduce financial distress by discouraging overly risky behavior. [68] argue that this paradox suggests some degree of enforcement leniency may benefit lenders by supporting more efficient investment decisions and facilitating adaptive contract terms.

From this perspective, enforcement influences not only debt contract design but also borrower behavior, credit availability, and systemic financial stability. Depending on how creditors respond—via screening, pricing, or lending thresholds—the overall default risk may increase or decrease in response to enforcement strength.

In the context of ESG performance and corporate culture, enforcement plays a dual role. In strong enforcement environments, ESG and culture help reduce default risk by reinforcing regulatory compliance and transparency. In weak enforcement settings, these internal factors can compensate for institutional gaps by signaling trustworthiness and reducing information asymmetry. Thus, we expect a negative relationship between ESG performance and default risk under both enforcement conditions, with corporate culture acting as a stabilizing moderator.

The sensitivity of this relationship remains an open research question. Nonetheless, evidence suggests that corporate culture can enhance the efficacy of ESG strategies, particularly where formal enforcement mechanisms are weak or costly, offering lenders reassurance through internal governance and ethical signaling.

3. Data and Methodological Framework

3.1. Sample Selection

The sample used in this study is drawn from several databases. First, we obtained the entire universe of earning calls transcripts available in Refinitiv Eikon. In this step, we downloaded more than 400,000 quarterly documents of firms belonging to different countries. Then, we measure corporate culture following [1] that use a cutting-edge machine learning technique: the word embedding model “word2vec”. As a result, we compute the five annual cultural values of quality, innovation, integrity, teamwork, and respect. In the third step, we merge this dataset with information related to firms’ distance to default. This information is retrieved from the Credit Research Initiative (CRI) database provided by the Risk Management Institute (RMI) of the National University of Singapore database.[1] Fourth, we obtain financial information and data related to ESG performance from LSEG Refinitiv (called in the past as Thomson Reuters-Eikon) and country-level data from the World Bank’s World Development Indicators (WDI). Finally, we delete firms with missing data, constraining our sample to those firms with information for at least four consecutive years.

The final dataset is an unbalanced panel of 39,505 firms-year observations (4,524 firms) over the period 2002-2023 and operating in 25 emerging and developed economies (Australia, Austria, Belgium, Brazil, Canada, Chile, China, Colombia, Denmark, Finland, France, Hong Kong, India, Ireland, Israel, Italy, South Korea, Mexico, Netherlands, Norway, Spain, Sweden, Switzerland, the UK, and the USA).

3.2. Variables

3.2.1. Dependent Variable: Measuring Distance to Default (DTD)

The main indicator of default risk is the distance-to-default provided by the structural credit risk model of [69]. This measure has been shown to be a good predictor of default, outperforming accounting-based models [70,71,72]. Overall, market-based measures are forward-looking, including the market information and exhibit higher explanatory power compared to accounting-based measures that are backward-looking.

Distance to default is measured as the difference between the market asset value of the firm ($V_A$) and the face value of its debt ($X$) maturing at time $T$, divided by the standard deviation of the firm’s asset value ($S_A$). In the [69] model, the market equity value ($V_E$) of a firm is modelled as a call option on the firm’s assets:

$V_E=V_{A}N\left(d_1\right)-X{e}^{-rfT}N\left(d_2\right)$

$$d_1={\displaystyle \frac{\log \left(\raisebox{1ex}{$V_A$}\!\left/ \!\raisebox{-1ex}{$X$}\right.\right)+\left(rf+\raisebox{1ex}{$S_A^2$}\!\left/ \!\raisebox{-1ex}{$2$}\right.\right)T}{S_A\sqrt{T}}};d_2=d_1-S_A\sqrt{T}$$

(1)

Where $r$ is the risk-free rate and $Div$ is the dividend rate expressed in terms of $V_A$. $S_A$ is related to equity volatility ($S_E$) through the following equation:

$$S_E={\displaystyle \frac{V_{A}N\left(d_1\right)S_A}{V_E}}$$

(2)

It requires solving simultaneously equations (1) and (2) to obtain the values of $V_A$ and $S_A$. To this end, It uses the market value of equity for $V_E$, total liabilities as proxy for the face value of debt $X$ and $m$ denotes the mean asset return.

Finally, Merton’s distance-to-default is computed as follows:

$$DTD={\displaystyle \frac{\log \left(\raisebox{1ex}{$V_A$}\!\left/ \!\raisebox{-1ex}{$X$}\right.\right)+(m-\raisebox{1ex}{$S_A^2$}\!\left/ \!\raisebox{-1ex}{$2$}\right.)T}{S_A\sqrt{T}}}$$

(3)

A higher value of $DTD$ indicates a greater distance to default and therefore a lower default risk. As we mention previously, we collect data on distance-to-default from the Credit Research Initiative (CRI) database. CRI improves the traditional estimation of distance to default by following the estimation technique proposed by [73], which using a forward intensity approach provide more robust default predictions and for shorter horizons.

3.2.2. Key Explanatory Variables: Corporate Culture and ESG

We measure the corporate culture variables developed by [1], which uses a machine learning technique to compute the culture score. Their method involves the use of a neural network model to comprehensively understand the contextual meaning of words and phrases found within earnings conference call transcripts. Subsequently, they develop a “culture dictionary” that encompasses terms and expressions associated with five key cultural values: innovation, integrity, quality, respect, and teamwork. This methodology entails calculating a weighted word count associated with each cultural value, which is then normalized by the total word count within the transcript. Notably, the authors substantiate the validity of their culture measurement through empirical analysis.

We estimate corporate culture using different measures. Initially, we compute a standardized composite score for each cultural value (sInnovation, sQuality, sIntegrity, sRespect, and sTeamwork), as defined by [4]. Then, our primary analysis employs these scores to calculate a standardized composite score of the five corporate cultural values (C. Culture) as employed in previous works (e.g., [74]). Additionally, we employ a binary variable, termed as Strong Culture, assigning a value of 1 when a firm’s culture score (C. Culture) is above the 75th percentile and 0 otherwise. Finally, we follow [75] and group the five corporate cultural values into two sub cathegories: technology-oriented culture comprised of innovation and quality (Technology Culture), and people-oriented culture comprised of integrity, respect, and teamwork (People culture), as defined previously. Accordingly, we compute the variables Strong People Culture and Strong Technology Culture defined by a binary variable, assigning a value of 1 when a company’s culture score (People or Technology culture) is above the 75th percentile and 0 otherwise. For a detailed explanation of all the variables, please refer to Appendix A.

Finally, related to ESG indicators, we use the overall ESG score (ESG) and its components environmental, social and governance scores. These variables measure the performance of firms on activities associated to protect the environment (Environment), the firms’ relationship with their stakeholders (Social) and their ability to to interact with the board of directors from a long-term perspective (Governance). These indicators are provided by Refinitiv Eikon.

3.2.3. Control Variables

Following previous studies (e.g., [76,77]), we incorporate a set of firm-specific $\left(X\right)$ and country-specific $\left(Y\right)$ characteristics, respectively. Regarding firm-level control variables, we include Size (log (Total Assets)), Leverage (total debt over total assets), MTB (The ratio of market to book value of equity), ROA (Net profits over total assets), PPE (Fixed assets over total assets), CAPEX (Capital expenditure over total assets). Related to country-level characteristics, we control for the annual growth rate of GDP (GGDP)and the annual inflation rate (INFLATION).

3.3. Descriptive Statistics

In Table 1, Panel A presents the distribution of firm observations in different countries and years. Panel B exhibits the mean of total assets (in millions) by country. We can observe that United States (63%), Canada (8%), the UK (6%), and France (3%) show the highest number of firm-year observations. However, China and France show the most significant average firm size.

Our sample is characterized by firms operating in different industries. Table 2 presents the sample distribution of firms by industry classification according to the 2-digit NAICS sector classification. We can observe that firms in our sample operate mainly in the manufacturing industry (33.53%), Finance and Insurance (14.17%), Information (8.38%) and, Professional, Scientific, and Technical Services (6.5%).[2].

Table 3 exhibits the main descriptive statistics for the variables used in the study. The mean (standard deviation) value of DTD is 5.327 (3.026), which is consistent with previous works on firms’ distance-to default (e.g., Safiullah et al., 2024). The 25th, 50th, 75th percentiles for DTD are 3.191, 4.831, and 7.03, respectively. These results would indicate a high heterogeneity in terms of default risk among firms at an international level. Concerning our corporate culture indicator (C.Culture), Table 3 shows a mean value of 1.112 and a standard deviation equal to 3.851. The 25th, 50th, 75th percentiles for C.Culture are -1.643, 0.486, and 3.170, respectively. Additionally, these results might suggest a high heterogeneity in terms of corporate culture among firms at an international level which is suggested by [1]. Moreover, we can observe slight differences with the statistics reported by [74], which might be explained by the wider sample used in this study (25 emerging and developed economies) that differs from the US sample analysed by [74].

Turning to the explanatory variables, the mean (standard deviation) value of the overall ESG score (ESG) is 45.37 (20.16). Related to the pillars comprising the overall ESG score, the mean (standard deviation) values of Environment, Social, and Governance are 34.78 (29.40), 47.50 (22.42), and 51.61 (22.07), respectively, suggesting that the governance score has the highest mean value, followed by the social and environment performance score, respectively. Given that our sample incorporates developing economies, firms’ efforts to improve their environmental performance are still in their early stages, scoring low in the environmental pillar. This might explain the low score of this ESG component in our sample.

3.4. Econometric Specification

In the first stage of our analysis, we test the validity of Hypotheses 1, 2 and, 3. Thus, we examine the relationship between ESG performance and corporate culture with firms’ distance to default. Then, we proceed to examine how a firm’s ESG performance and its corporate culture interact in explaining its corporate default risk. To do this, we propose the following baseline equation model:

$${DTD}_{i,t}={\beta }_0+{\beta }_1{ESG}_{i,t}+{\beta }_2{CorporateCulture}_{j,i,t}+{\beta }_3{ESG}_{i,t}\times {CorporateCulture}_{j,i,t}+\gamma \text{'}{X}_{i,t-1}+\theta \text{'}{Y}_{c,t-1}+YearFE+IndustryFE+{\epsilon }_{i,t}$$

(4)

Subscripts $i,c,$and $t$ represent the firm, country, and year respectively. ${DTD}_{i,t}$is the default risk of firm $i$ in year $t$ based on [69] and provided by the Credit Research Initiative (CRI) database, which improves the conventional estimation of DTD by following the estimation technique proposed by [73]. $CorporateCulture$ represents our main corporate culture variables ($C.Culture$ and/or $StrongCulture$). In additional analysis, we also experiment with the underlying subcultures People and Technology cultures as defined above. $X$ and $Y$ are the set of the firm- and country-specific control variables, respectively. We also incorporate year and industry fixed effects. Finally, we estimate our baseline model using OLS regressions and employ robust clustering of standard errors at the firm level. Finally, in our panel regression estimates, we follow the extant literature and take a one-year lag for all control variables to minimise endogeneity issues [79,80,81]^[3]. For a detailed explanation of all the variables, please refer to Appendix A.

4. Results

4.1. ESG Performance and Firms’ Default Risk

We start reporting a set of panel regressions over the period 2002-2023 to examine the role of a firms’ ESG performance in increasing or reducing default risk. We also study the relationship between corporate culture and distance to default.

Table 4 presents the results for the different estimations of baseline model considering as the dependent variable the Merton’s distance-to-default ($DTD$), the main variable of interest ($ESG$), the corporate culture variable (C.Culture) and the set of control variables related to the firm and country characteristics. In columns (1) to (3) we examine separately and simultaneusly the role of ESG performance and corporate culture in influencing default risk, and without including the sets of control variables. In columns (4) to (6) we proceed to explore the influence of our control variables in the effect of $ESG$, and $C.Culture$ on $DTD$.

All the estimations reported in Table 4 show a positive and statistically significant effect of $ESG$ on $DTD$. We can observe that the coefficient on the $ESG$ is, on average, 0.018 and statistically significant at the 1% level, which provides evidence of the role of the firm’s ESG performance in influencing corporate default risk. This result confirms our Hypothesis 1 (H1). Along the same line, the results shown in Table 4 report a positive and statistically significant effect of $C.Culture$ on $DTD$, which is statistically significant at the 1% level. This indicates that those firms scoring high in our corporate culture index are associated with lower levels of default risk. This support our Hypothesis 2 (H2). Given this latter finding, we proceed to replace $C.Culture$ with $StrongCulture$ in our baseline model, and repeat the estimations presented in Table 4. Consequently, the findings shown in Table 5 provide evidence of a positive and statistically significant effect of $ESG$ on $DTD$, allowing to validate our Hypothesis 1 (H1). Table 5 also allow us to infer a positive relationship between firms with a strong corporate culture and their default risk. In other words, firms with a strong culture are associated with a lower level of default risk, supporting Hypothesis 2 (H2).

4.2. ESG and Default Risk: The Moderating Role of Corporate Culture

To examine the validity of Hypothsis 3 (H3), we run our baseline model in which our primary variable of interest is ${\beta }_3{ESG}_{i,t}\times {CorporateCulture}_{j,i,t}$, for which we hypothesize a positive and statistically significant effect. Specifically, we expect that those firms with higher ESG performance and a strong corporate culture exhibit less default risk. Table 6 and Table 7 display the estimation results considering to $C.Culture$ and $StrongCulture$ as the corporate culture variable in each table, respetively. Table 6 shows a positive and statiscally significant effect of ESG on DTD, and our key variable of interest ${\beta }_3{ESG}_{i,t}\times {C.Culture}_{j,i,t}$ exhibits, on average, a coefficient equal to 0.001 and statistically significant at 1% level. Similarly, Table 7 presents a positive and statistically coefficient stimes on ${\beta }_3{ESG}_{i,t}\times {StrongC.Culture}_{j,i,t}$ that is, on average, equal to 0.01.

Additionally, Table 6 and Table 7 report Lincom, to test the importance of the sum of coefficients for ESG and for the interacetd variable with C.Culture (${ESG}_{i,t}\times {CorporateCulture}_{j,i,t}$). The test confirms that the addition of the coeficcients is positive and statistically significant at 1% level, and thus the net effect of ESG performance in firms with strong culture is a lower level of default risk (Higher DTD). Therefore, the results presented in both tables provide support to our Hypothesis 3 (H3).

Given the high participation of the US firms in our sample (secction 3.3, Table 1), we conduct an additional analyzes excluding the US firms from our estimations. Table 8, presents these results and corroborate Hypothesis 3 (H3), as shown in previous table.

Now, we further analyze the impact of ESG and its interacted effect with corporate culture on default risk by taking a closer look at the pillars that comprise the overall ESG score. In Table 9 and Table 10, we interact separaltely the variables associated to these pillars, specifically, $Environment$, $Social$, $Governance$ with $C.Culture$ and $StrongCulture$, respectively. Overall, the findings displayed in Table 9 and Table 10 do not provide evidence of differences on the interacted effect between each pillar and the variables related to corporate culture. Similar to previous findings, we can observe a positive and statistically significant effet of each ESG pillar on DTD as well as positive and statistically significant interacted effect with corporate culture on DTD.

Once we have explored the impact of the pillars comprising the overall ESG score, we consider the subcultures that explain corporate cultures. We follow [75] and cluster the five cultural values underlying a corporate culture into two subcultures: Technology Culture comprised of innovation and quality, and People Culture comprised of integrity, respect, and teamwork, as defined previously. We also define Strong People Culture and Strong Technology Culture as a binary variable, assigning a value of 1 when a company’s culture score (People or Technology) is above the 75th percentile and 0 otherwise.

Consequently, we replace in the baseline model to examine how these two subcultures, separately, interact with the ESG performance shown by a firm in decreasing or increasing corporate default risk.

In Table 11, we examine whether and how a people- and technology-oriented culture helps firms to reduce their default risk. Additionally, we examine their interaction effect with ESG performance on a firm’s distance to default. In Panel A of Table 11, Column (1) reports a positive and statistically significant effect of a people-oriented culture on corporate default risk. This effect is statistically significant at 1% level. However, in Column (2) we observe that the interactive effect of ESG score*People Culture is positive and statistically significant but only at 10% level. Column (3) shows a positive and statistically significant effect of a technology-oriented culture on corporate default risk, which is statistically significant at 1% level. Additionally, Column (4) shows that the interactive effect of ESG score*Technology Culture is positive and statistically significant at 1% level. These findings suggest that technology rather than people-oriented corporate culture would explain the positive moderating effect of corporate culture on the relationship between firms’ ESG performance and their default risk.

Along the same lines, in Panel B of Table 11, we examine the role of a Strong People Culture, a Strong Technology Culture and its interactive effect with firms’ ESG performance on the default risk faced by firms. Similar to Panel A, findings reported in Panel B show that the interactive effect of ESG score*People C.Culture on DTD is positive and statistically significant but only at 10% level. In contrast, the impact of ESG score*Technology Culture on DTD remains positive and statistically significant at 1% level. Therefore, the results provided in Table 11 would entail that those firms with corporate strategies technologically sound and, thus, encouraging a strong technology-oriented culture would take advantage of the positive effect of ESG performance on reducing their default risks.

4.3. Default Risk, ESG and Corporate Culture: Life Cycle

To examine the validity of our Hypotheses (H4) and (H5), we conduct a subsample analysis between firms in different life cycle stages. Following the extant literature, we use two proxy variables for the life cycle; the firm age, Firm Age, ([3]) and the ratio between retained earnings over total assets, RETA, ([82]). Then, we classify as mature firms to those with Firm Age and RETA greater than the sample median and, as young firms those with Firm Age and RETA below the sample median.

In Table 12, we report the estimation results of our baseline equation model for each subsample of firms (Mature and Young). In Panel A, B, C, and D we show our estimations results for the overall ESG score and the pillars defined by Environment, Social and, Governance, respectively, as well as each interactive effect with C.Culture. Columns (1) and (2) report the regression estimates for the subsample where the variable Firm Age is greater and lower than the sample median, respectively. Columns (3) and (4) report the regression results for the subsample where the variable RETA is greater and lower than the sample median, respectively. First, we can observe that the role of firms’ ESG performance (ESG, Environment, Social and, Governance) on reducing their default risk is more accentuated for young firms than for mature firms. Second, the moderating role of corporate culture on the relationship between ESG performance and firms’ distance to default is stronger for mature firms compared to young firms. In other words, these findings suggest that older firms are capable to accentuate the positive effect of ESG on reducing corporate risk through their corporate culture. These findings are consistent with our Hypothesis (H4) but we are not able to confirm Hypothesis 5 (H5).

4.4. Additional Analysis: Heavy-Polluting Industries and Enforcement

Previous literature contend that heavy-industry firms tend to exhibit a higher carbon footprint and, thus, face more challenges in improving their ESG performance ([78]), influencing the company default risk. In this section, we explore whether firms operating in heavy-polluting industries exhibit a positive/negative moderating effect of corporate culture on the relationship between ESG performance and default risk.

Now, we move to investigate the potential role impact of Enforcement on the the moderating role of corporate culture analyzed so far. Specifically, we study the potential influence of legal environment (Enforcement). We differentiate between countries with high (low) enforcement.

Similar to tables above (Table 12 and Table 13), Table 14 shows the influence of a high and low level of enforcement on the mitigating role of corporate culture. Interestingly, Panel A shows a positive and statistically significant effect of$ESG*C.Culture$ on $DTD$ for firms belonging to countries with Low Enforcement. Column (2) shows a relationship that is statistically significant at 1% level and, in contrast, Column (1), for high enforcement, exhibits a relationship statistically significant at 10% level. These would suggest that for countries with poorer legal environment, a strong culture accentuates the effect of a firm’s ESG performance on reducing its default risk. Similar results are observed in Panel D, in which the interacted effect of Governance*C.Culture is more pronounced for firms operating in countries with poorer legal environment (Low Enforcement). Regarding the environmental and social pillars, the results presented in Panels B and C, do not allow us to observe significant differences on the moderating role of corporate culture between the subsample of firms. As we expected, countries with poorer enforcement show a more influencial effect of C.Culture on the relationship between ESG score and default risk.

4.5. Endogeneity: 2SLS-IV and PSM

To further mitigate endogeneity concerns, we use two econometric technics. First, we use a 2SLS instrumental variable approach. The 2SLS-IV approach allows us to explore the exogenous impact of corporate culture on the corporate default risk, solving the problem of reverse causality. In the first stage, we consider corporate culture as endogenous and it is instrumented by an external instrument. In the second stage, we use the predicted values estimated from the regression carried out in the first stage and use them as a proxy variable for corporate culture.

For the IV approach we need instruments that satisfies the criteria of relevance (i.e., correlated with the corporate culture) and exclusion (i.e., no direct effect on default risk except through the corporate culture) from a theoretical and econometric perspective ([83,84]). It is worth mentioning that finding suitable instruments for corporate culture is very difficult ([85]), however we rely on the previous studies to develop our instrumental variable. Following the extant literature in the subject ([8,86,87]), we use the average corporate culture industry, country, and size in each year as our instrumental variable. The selection of this instrumental variable is based on heterogeneity of our international sample of firms, in terms of countries, industries and, firms’ characteristics.

In Table 15 we report the p-value for the Kleibergen-Paap rk LM statistic for the under-identification test. The p-values are below the 10% critical value, which allows us to reject the null hypothesis that the equation is under-identified. We also report the Kleibergen-Paap rk Wald F-statistic for the weak instruments test. The values of the F-statistics are above the cut-off value (Stock-Yogo critical values), which suggests that we can reject the null hypothesis that the instruments are weak. Finally, the Hansen J p-value does not allow us indicate that instrument is uncorrelated with the error term.

Column 1 of Table 16 reports the results of the first-stage regression where the dependent variable is the corporate culture. The explanatory variables include the above-mentioned instrument and the same control variables as in the baseline regression. Consistent with the rationale behind the instrument, the corporate culture is positively correlated to the instrumental variable. The coefficient estimate for the instrument in Column 1 is statistically significant at the 1% level suggesting that our instrument is valid. Column 2 of Table 16 displays the results for the IV regressions and shows that the coefficients C.Culture and the interaction term $ESG\times C.Culture$ are positive and statistically significant. Therefore, this finding support that our baseline results remain unchanged after controlling for potential endogeneity issues by using the IV-2SLS methodology.

Additionally, we use the entropy balanced matching approach of [88]. With this approach, each observation in the control group is weighted such that the post-weighting distributions of each matching control variable for the treatment and control groups are identically distributed. This rebalancing scheme of the control sample applies new weights to each observation in that sample so that the distribution moments of the first three moments of the covariates are equalized across treatment and weighted control observations. Column (3) of Table 16 shows the regression results after reaching a covariate balance via entropy balancing and for the main dependent variable Merton’s distance to default. In line with results reported previously, Column (3) shows a negative and statistically significant effect of $ESG\times C.Culture$ on $DTD$. Column (4) and (5) exhibit the mean (variance) of covariates after applying entropy balancing whereby the first two moments (mean and variance) are equalized between the treatment and control groups. Treatment group is defined as those firms with strong culture and the control group is represented by those firms without strong culture (Thi Nguyen et al., 2023) As it can be observed in these columns, covariate balance for all control variables is achieved and, in turn, the two groups (or samples) are identically distributed for each control variable. This outcome assures that any remaining differences in the outcome variable (distance to default) between the groups are driven by the main independent variables given by $ESG\times C.Culture$.

5. Summary and Conclusions

The main focus of the article is to observe how C.Culture impacts default risk (lower DTD). Actually, strong technology culture seems to explain most of the results. Firstly, this study shows a positive relationship between corporate culture (C.Culture) and DTD. Secondly, C. Culture has a positive impact on the relationship between ESG and DTD, serving to the reduce default risk. Thirdly, mature firms exhibit a higher DTD and when C. Culture is used as a moderator factor for mature firms, the relation between ESG and DTD becomes higher, which is not the case for younger firms. Similar results are obtained when polluting industries are included in the analysis. Fourthly, for polluted industries with strong corporate culture this study reports a positive relationship between ESG-E and DTD. This result is also significant when the general ESG score is employed, but not for the other two pillars (Social and Governance). Additionally, when the sample is classified by SDGI, we are not able to observe significant differences between firms that are either in High or Low SDGI. Finally, for countries with poorer enforcement C.Culture plays a relevant role in the reducing the default risk as itself and also as a moderator variable between ESG and default risk. When the firm faces a low level of enforcement, corporate culture emerges as an intangible asset to enhance the negative relationship between default risk and ESG performance.

This research reveals how important is to count with a strong corporate culture in the firm. This not mitigates the default risk but also act as an effecting moderating factor in the relationship in firms which are: mature; belong to heavy polluting industries; and face poor enforcement.

Regarding policy making, governments can establish regulations and standards that promote ethical behavior, transparency, and accountability within corporations. For example, laws related to corporate governance, anti-corruption, and environmental protection can encourage companies to adopt responsible practices. Governments can create programs that recognize and award companies for their positive corporate culture and social responsibility efforts. Indeed, countries such as UK are requiring to report the corporate cultural values. Public recognition can enhance a company’s reputation and encourage other companies to follow suit. Governments can provide funding and support for training and development programs that help employees develop skills and knowledge. This can contribute to a culture of continuous learning and improvement within the organization. Finally, Governments can implement policies that promote work-life balance, such as flexible working hours and parental leave. These policies can help create a supportive and inclusive work environment. By implementing these policies, governments can create an environment that encourages companies to develop a positive corporate culture, ultimately benefiting both the organizations and society as a whole.

In terms of future research, we suggest to increase the sample size to have more countries represented. It will be also interesting to separate between family and non-family firms, due to the particular characteristics of family firms.