Porta Michela 

The relationship between ESG Performance and 
Financial Stability: are sustainable companies less 

likely to fail? 

European evidence 

 

Academic Supervisor: Tatiana Garanina 

 

 

 

 

 

  

Vaasa 2023 

 

 

School of Accounting and Finance 

Master’s thesis in Finance 

 



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UNIVERSITY OF VAASA 
Master’s thesis in Finance 
Author: Porta Michela 
Title of the thesis:  The relationship between ESG Performance and Financial 

Stability: are sustainable companies less likely to fail?  
European evidence 

Degree: Master of Science in Economics and Business 
Discipline: Finance  
Supervisor: Tatiana Garanina  
Year: 2023 Pages: 8485 

 

ABSTRACT :  
The purpose of this thesis is to study if high ESG performance is related to firm performance, 
specifically their bankruptcy probability, which is measured by Altman Z-Score in European 
countries. 
The sample includes 1740 different companies during the period 2011-2021. Moreover, this 
thesis aims to study whether there are ESG pillars that impact a firm’s financial performance the 
most. 
 
The importance of corporate sustainability and responsibility has grown in recent decades, 
driven by factors such as environmental and societal concerns, including climate change and 
human rights issues, legislative changes, and shifts in public sentiment..  Consequently, 
companies are trying to improve their way of employing and disclosing sustainability strategies 
and environmental, social, and governance (ESG) information. This has caused the need for 
fundamental changes in business models and management.  
 
However, previous literature has not come yet to a solid conclusion on whether ESG 
Performance (ESGP) and corporate financial stability are related or not. Many studies suggest 
that this relationship is positive, others, on the other end, found a slightly negative correlation 
or a non-linear link.  
 
This thesis aims to investigate if the financial performance of European companies is related to 
their ESG ratings for the years 2011-2021. The FDR (Financial Distress Risk) is measured with the 
Altman Z’’-Score, a statistical method used to calculate the probability of firms’ bankruptcy, 
while the Refinitiv ESG Combined Score is used as a proxy for environmental, social, and 
governance performance. The results, once again, prove that the link between these two 
variables is not as simple and linear as one may think. The ESGP-FDR relationship is influenced 
by numerous factors, and the outcomes appear to be relatively neutral and diverse. 
Consequently, based on the findings of this thesis, it is challenging to definitively assert whether 
high ESG scores exert a more positive or negative impact on firms' financial performance in 
Europe. 
 
 
 
 

KEYWORDS: Environmental, social, governance (ESG), Altman Z-Score, Financial 

stability, Bankruptcy probability, ESG Score, firm performance 



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Contents  

1. Introduction 7 

2. Literature Review and Theoretical Background 13 

2.1 Shareholder Theory 13 

2.2 Stakeholder Theory 15 

2.3 Agency Theory 18 

2.4 The link between ESG pillars and Corporate Financial Performance 21 

2.4.1 ESGP-CFP Positive Link 23 

2.4.2 ESGP-CFP Negative link 26 

2.4.3 Non-decisive results 28 

3. Hypotheses 31 

4. Data and Methodology 33 

4.1 Regression Model 33 

4.1.1 Regression Model 33 

4.1.2 Dependent Variable 35 

4.1.3 Independent Variables 35 

4.1.4 Control Variables 38 

4.2 ESG pillars 41 

4.3 The Altman Z-Score 46 

4.3.1 Classic Altman Z-Score Model 49 

4.3.2 Altman Z’-Score and Z”-Score Models 51 

4.4 Data collection and description 52 

4.4.1 Altman Z-Score as a proxy for financial performance 56 

4.4.2 Refinitiv ESG Combied Score as a proxy for ESG Performance 61 

5. Empirical Analysis 66 

5.1 Regressions results 66 

5.2 Summary of results and limitations 71 

6. Conclusions 73 

REFERENCES 74 



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List of figures 

 

Figure 1. Environmental pillar score matrix 

Figure 2. Social pillar score matrix 

Figure 3. Governance pillar score matrix 

Figure 4. Evolution of ESG scores from 2011 to 2021 

Figure 5. ESG pillars (CFA Institute, 2022) 

Figure 6. Refinitiv ESG score (Refinitiv.com, 2022) 

Figure 7. Refinitiv ESG score formula 

Figure 8. ESG score quantiles 

Figure 9. ESG Grades 

Figure 10. ESG Score categories 

Figure 11. Refinitiv ESG scoring methodology 

Figure 12. Trend of the Altman Z’’-Score per industry over years 

Figure 13. Trend of the Altman Z’’-Score over years 

Figure 14. Trend of the ESG combined score over years 

Figure 15. Comparison between ESG Score and Altman Z’’-Score over the years  



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List of tables 

 

Table 1. ESG Sample Distribution 

Table 2. Altman Z’’-Score Sample Distribution 

Table 3. Country Distribution of the Sample 

Table 4. Industry Distribution of the Sample’s Companies 

Table 5. Variables Descriptive Statistics 

Table 6. Altman Z’’-Score by Country 

Table 7. Altman Z’’-Score Descriptive Statistics 

Table 8. Average Altman Z’’-Score per Year and Industry 

Table 9. ESG Scores Descriptive Statistics 

Table 10. Average ESG Scores per Year 

Table 11. Average ESG Combined Score per Year and Industry 

Table 12. Correlation Table 

Table 13. Z’’-Score Regression Results for ESG Combined Score 

Table 14. Z’’-Score Regression Results for Each ESG Pillar Score 

Table 15. Altman Z’’-Score Regression Results for a Time Lag of 1, 2, and 5 Years. 

  



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Acronyms 

CFP     Company financial performance 

CSR     Corporate social responsibility 

EBIT    Earnings before tnterest and taxes 

ESG     Environmental, social, and governance 

ESGP   Environmental, social and governance performance 

EU       The European Union 

FDR     Financial distress risk 

MDA   Multiple discriminant analysis model 

MSCI   Morgan Stanley Capital International 

ROA    Return on assets  

ROCE  Return on capital employed 

ROE     Return on equity 

US       The United States 

  



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1. Introduction 

In the past several years, the interest in environmental and social sustainability has 

begun to rise among customers, investors, and consequently companies (Brockett & 

Rezaee, 2012). The number of companies implementing sustainability strategies and 

disclosing information related to environmental, social, and governance (ESG) is steadily 

increasing, and this practice is bound to spread also due to the increasing regulations 

set by governments and institutions. This has caused the need for fundamental changes 

in business models and management. 

Three are the main theories that debate what the final purpose of companies should be 

and who should benefit from it. These are the shareholder, the stakeholder, and the 

agency theory. The first one, introduced by Friedman (1970), claims that the only goal 

for companies should be to improve financial performance and maximize the 

shareholders’ profits. On the other hand, Freeman (1984) argues that business 

executives should take into consideration the interest of all stakeholders, internal and 

external, because that is the only way in which firms can secure long-term success. Then 

again, Jensen and Meckling (1976) suggested that the separation of ownership and 

control in a company can lead to agency problems, which arise when the interests of the 

principal (such as shareholders) and the agent (such as management) are not aligned. 

Therefore, managers will always try to benefit themselves at the expanse of 

shareholders if not monitored. These debates have developed over the years and now 

concern the question of whether investing in ESG activities is a profitable action for 

some stakeholders and if the company can also gain advantages by doing it. This thesis 

aims to answer that question using two main parameters, the Altman Z-Score and the 

Refinitiv ESG Combined Score.  

The Altman Z-score is a financial ratio that is used to predict the probability of a company 

going bankrupt within the next two years. It was developed by Edward Altman, a 

professor at New York University's Stern School of Business, in the 1960s. This model 

was found to have a correctness rate of about 78% by Begley et al. (1996) and a recent 



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article has shown an overall success rate of 87,3% in Italian companies in the year before 

economic failure and of 66,6% three years before it (Celli, 2014).  

Moreover, this score is considered to be a good indicator of a company's financial 

performance because it takes into account five different financial ratios that are known 

to be important indicators of a company's financial health. For example, the ratio of 

working capital to total assets is an indicator of a company's ability to pay its short-term 

debts, while the ratio of retained earnings to total assets is an indicator of a company's 

ability to generate profits over the long term. By combining these and other ratios into 

a single score, the Altman Z-score provides a quick and easy way to gauge a firm’s 

financial distress risk (FDR) and a company financial performance (CFP).  

In fact, financial stability and financial performance are often correlated because a 

company that is financially stable is more likely to be able to achieve good financial 

performance. Osamor and Adenbanjo (2020, pp. 137-138) assert in their study that the 

financial stability of a firm is intricately linked to its capacity to generate profits, enhance 

the value of invested capital, and concurrently repay its short and long-term liabilities. 

This is because financial stability provides a company with the resources and flexibility 

to invest in its business, such as through research and development or marketing efforts, 

which can improve its financial performance. For this reason, in the following pages, we 

will often use corporate financial performance (CFP) and corporate financial stability as 

interchangeable terms. 

The indicator used for assessing the company’s ESGP is the Refinitiv ESG Combined 

Score, which is a measure of a company's environmental, social, and governance 

performance. It is calculated by Refinitiv, a financial markets data provider, and is based 

on publicly available information on a company's ESG performance. The score is 

intended to provide investors with a quick and easy way to understand a company's ESG 

performance and compare it to other companies. The score is expressed as a number 

on a scale from 0 to 100, with higher scores indicating better ESG performance. The 

score is based on a variety of factors, including a company's greenhouse gas emissions, 

labor practices, and corporate governance. 



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Several studies have found that companies with strong ESG practices are less likely to 

experience financial distress or go bankrupt. For example, Gao et al. (2015) found that 

companies with higher ESG scores were less likely to go bankrupt, particularly in 

industries with high environmental regulations. Liu et al. (2017) also found that 

companies with strong ESG practices had lower credit risk and were less likely to default 

on their bonds, which is a strong predictor of bankruptcy. In addition to its impact on 

financial distress risk and bankruptcy probability, research has also suggested that 

strong ESG practices may be related to improved financial performance. Denis et al. 

(2015) found that companies with better ESG practices were able to attract and retain 

top talent, which can lead to improved financial performance. Moreover, companies 

with strong ESG practices may have strong relationships with stakeholders, which can 

provide a cushion in times of financial stress and lower the likelihood of bankruptcy (Liu 

et al., 2017). 

Other research, such as the one of Chan et al., (2017), examines the effect of Corporate 

Social Responsibility (CSR) on the level of financial liquidity/distress of firms. Chan et al.’s 

results confirmed the view of Campbell (2007), that there is a significant negative 

association between CSR activities and the level of financial distress or constraints. The 

term corporate social responsibility (CSR) refers to a company's commitment to being a 

good corporate citizen and to taking responsibility for its impact on society and the 

environment. ESG and CSR are two distinct, yet related, concepts that address the 

sustainability and ethical impact of a company (Bhattacharya et al., 2009). ESG refers to 

three criteria that investors use to evaluate a company's performance, including its 

environmental impact, its treatment of employees and other stakeholders, and the 

effectiveness of its governance practices (Orlitzky et al., 2003; Dahlsrud, 2008). CSR, on 

the other hand, involves a company's commitment to being a good corporate citizen and 

to taking responsibility for its impact on society and the environment (Carroll, 1991). 

Both ESG and CSR focus on sustainability and corporate responsibility (Helfat et al., 

2016), but ESG is often used as a measure of a company's performance by investors 

(Sustainable Investing, 2021), while CSR is typically used to describe a company's efforts 

to be socially and environmentally responsible (Smith, 2011). Additionally, ESG criteria 



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are often more specific and quantifiable than CSR efforts (Sustainable Investing, 2021), 

which can make it easier to compare the performance of different companies 

(Brunnermeier et al., 2016). However, overall, they are closely related and can be 

considered as two sides of the same coin and are both important considerations for 

companies seeking to be more sustainable, responsible, and accountable (Deloitte, 

2019). For this reason, in the following pages, these two terms will often be used as 

synonyms, as also Helfat et al. (2016) suggest. 

However, not all studies have found a consistent relationship between ESG performance 

and financial distress risk or bankruptcy probability. Some studies have found non-linear 

or inconclusive relationships between the two (Kwok et al., 2014; Zhang et al., 2020). 

Additionally, the relationship between ESG performance and financial distress risk or 

bankruptcy probability may vary depending on the industry and other factors (Bruna et 

al., 2021) 

To sum up, from the many studies that have investigated ESGP and CFP relationship 

(Benabou & Tirole, 2010; Cohen, 1988; Rosenthal & Rosnow, 1991; Friede et al., 2015; 

Xie et al., 2017; Velte, 2017; Bruna et al., 2021; Batae et al., 2021; Atan et al., 2018; Jyoti 

and Khanna, 2021; Damers et al., 2021), two are the most common results obtained. On 

the one hand, according to the Porter hypotheses (Porter & van der Linde, 1995), ESG 

activities bring innovation which creates extra income that can cover the additional 

costs, so a proper ESG strategy can lead to an increase in CFP. The majority of empirical 

studies display a positive link between ESG and CFP (Orlitzky et al., 2003; John, 1992;  

Deng et al., 2013; Margolis et al., 2009). On the other hand, ESG activities bring 

additional costs caused by inefficient resource allocation, which may put a firm in 

difficulty and therefore make ESGP negatively related to CFP. Moreover, non-linear and 

neutral relationships have also been found between the company ESG Performance 

(ESGP) and CFP (Xie et al., 2017; Velte, 2017; Bruna et al., 2021). The ambiguity in the 

findings leaves unresolved questions.  

The failure to develop a consensus on the implications of ESG for CFP can be attributed 

to a number of factors including lack of standardization and agreement on what 



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constitutes "good" ESG performance, lack of data and transparency, and differing 

opinions on the trade-offs between financial performance and ESG consideration (Lee 

& Kim, 2023). Additionally, the field of ESG and CFP is relatively new and constantly 

evolving, making it difficult to reach a consensus. It also has been a debate between 

short-term financial performance vs long-term sustainability.  

For example, the large range of CFP indicators makes it impossible to draw broad 

conclusions about this issue because each indicator measures different aspects of 

financial performance and uses different methods and data sources. This can lead to 

inconsistent or conflicting results when comparing companies and/or industries. 

Additionally, some CFP indicators are based on historical data while others are based on 

forward-looking projections, which further complicates the comparison. The main two 

types of indicators used are market-based measures, such as share price, mutual fund 

returns, and market value (Peloza, 2009), and accounting-based metrics like return on 

assets (ROA) and return on equity (ROE) (Ferrell et al., 2016; Lee et al., 2014). However, 

these two indicators are influenced by different factors, for instance, share price 

variations may be influenced by news and by the perception of a company among 

investors and the broader public. Positive ESG performance can improve a company's 

reputation and brand image, which can lead to increased investor confidence and higher 

share prices. On the other hand, ROA and ROE are not directly affected by public opinion 

and a sustainable company may not be performing well financially due to other factors 

such as economic conditions or intense competition. 

Moreover, commonly used metrics often miss the mark when it comes to ESG 

implications. In addition to that, there are a lot of ESG scores and indicators that can be 

used to assess corporate sustainability. Each of them focuses on different areas and data 

and could, therefore, lead to a different ESG rating for the same company. For all these 

reasons, studies that use different types of ESG and CFP metrics may get different results 

about the ESG–CFP relationship. Thirdly, as highlighted by Barnett and Salomon (2006), 

there is no rigidly defined positive or negative correlation between Corporate Financial 

Performance and Environmental, Social, and Governance Performance . Many are the 

studies that proved a nonlinear relationship between the two variables (Trumpp & 



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Guenther, 2017; Fujii et al., 2013), because the relationship can depend on a variety of 

factors such as industry, specific ESG issues, geography, size and ownership structure 

and time. 

In this thesis, we investigate whether this link between environmental, social and 

governance factors and corporate financial performance in European companies either 

exists or not. The firms investigated are listed in 35 different European countries and are 

analyzed for the period from 2011 to 2021, the study takes into consideration both well-

performing businesses and distressed ones (Altman Z’’-Score < 1.81). Since most of the 

studies focus on the stock performance, more than on the real financial situation of the 

company and the bankruptcy probability, we decided to calculate the CFP with 

accounting and financial data, by using the Altman Z-Score as an indicator. As previously 

said, instead, the ESGP is measured with the Refinitiv ESG Combined Score.   

The findings of this study could be useful for investors, managers, and policymakers to 

make decisions related to ESG pillars. For example, investors by understanding the 

relationship between ESG and financial performance can make more informed decisions 

about where to allocate their capital, decide to consider ESG pillars in their investment 

decisions, and potentially benefit from the better financial performance of companies 

that are more sustainable and responsible. For managers, on the other hand, knowing 

the nature of the link between ESGP and CFP can help them identify opportunities to 

improve the sustainability and ethical performance of their company and by focusing on 

ESG issues, they can potentially improve their company's reputation, attract and retain 

top talent, reduce risks and costs associated with environmental and social issues (ESG 

Investing, 2021) and make the company more profitable overall. Furthermore, 

policymakers can use this information to better develop policies and regulations that 

encourage companies to adopt more sustainable and responsible practices. By 

encouraging companies to prioritize ESG issues, policymakers can help to create a more 

sustainable and equitable society, while also potentially supporting the financial 

performance of companies. 



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In the following chapters, we will illustrate the theoretical background, the previous 

literature and the hypotheses. After that, the data collection method is described with 

the applied methodology. Then, the regression model used is explained together with 

its results. In the end, a summary of the analysis and its limitations are given.  

 

2. Literature Review and Theoretical Background 

This chapter presents the previous theories and studies on the subject. First, the three 

main theories about companies’ strategies and purpose are illustrated: the shareholder 

theory, the stakeholder theory, and the agency theory. Then, the concepts of ESG and 

Altman Z-Score are explained, these two concepts are crucial for the development of 

this thesis. After that, the previous researches concerning the relationship between 

ESGP and CFP/financial stability are described. The aim of this chapter is to offer a 

comprehensive overview of various perspectives and lay the groundwork for 

subsequent chapters, providing a thorough background for further exploration. 

First, we introduce the three theories about corporations’ objectives and 

responsibilities. These debate whether companies should only care about profit 

maximization, or whether they should also consider having non-economic, social, and 

environmental goals as well.  

 

2.1 Shareholder Theory 

The Friedman doctrine, also known as the shareholder theory, claims that companies’ 

goal should only be to maximize their profit. Friedman views the shareholder as the 

economic engine of the organization and therefore, as the only group for which the firm 

should care. It is not the company’s responsibility to take part in social initiatives, since 

it will be the single shareholder to decide for themselves in which social or 

environmental project invest in (Friedman, 1962). 



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Friedman first introduced this theory in his book Capitalism and Freedom (1962), and 

then in a later essay titled “Social Responsibility of Business” (1970). In the first 

formulation, he says that the only obligation of businesses that operate in open and free 

competition without deception or fraud is to maximize their value.  

“In such an economy ["a free economy"], there is one and only one social 

responsibility of business-to use its resources and engage in activities 

designed to· increase its profits so long as it stays within the rules of the 

game, which is to say, engages in open and free competition without 

deception or fraud.” 

While, in the second formulation, he states that business executives have to follow the 

wishes of shareholders while obeying the laws (Carson, 1993).  

According to Carson, in a free-enterprise, private property system, a corporate executive 

serves as an employee of the business owners. Their primary responsibility is to fulfil the 

wishes of their employers, typically centred around maximizing profits within the 

framework of societal rules, encompassing both legal statutes and ethical conventions. 

Carson acknowledges that, in some instances, the objectives of employers may diverge, 

such as when a group establishes a corporation for philanthropic purposes, like a 

hospital or a school. In such cases, the manager's focus shifts from profit to the provision 

of specific services. 

Moreover, Friedman (1962) argues that corporate social responsibility (CSR) may 

deteriorate the free-enterprise system and move society towards a more centrally 

controlled system. That is because, if companies start to take socially responsible 

actions, such as setting a minimum wage or buying raw materials only from 

environmental-friendly businesses, the price of the final product will rise and will lead 

to product shortages, grey markets, or black markets. All these actions can only be taken 

by the government, but if it does so, it will lead to a centrally controlled system.  

In addition to that, Friedman (1970) sees the view that firms should have a social 

conscience, as a “pure and unadulterated socialism” and argues that the businessmen 

who are pro-social advocates are “unwitting puppets of the intellectual forces that have 



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been undermining the basis of a free society these past decades” (Friedman, 1970). To 

support his view, he claims that companies investing in social initiatives are spending 

someone else’s money for general interest, and this surely does not profit the investors. 

Furthermore, these actions may reduce shareholders’ gain, raise the product prices for 

customers, and lower some employees’ wages. 

In conclusion, companies should only care about shareholders’ interests and spend their 

money on investments that provide a return for them. Any other action that does not 

directly benefit the shareholders is an inefficient allocation of capital and a decrease in 

the degree of freedom in society. 

However, the world has changed a lot in the last 50 years, and the Friedman theory 

could be seen as not relevant as it was before. Shareholders nowadays care more and 

more about social and environmental factors, and many stakeholders investigate the 

ESG value of companies before investing in them (Ruf et al., 2001). 

This is why the Friedman doctrine has attracted criticism over the years, especially since 

the financial crisis of 2007–2008, which was triggered by various financial institutions 

that in order to maximize stakeholders’ profit engaged in excessive risk, resulting in the 

collapse of the American real estate market and a global economic crisis. An opposite 

view is offered by Freeman (1984) in his book Strategic Management: A Stakeholder 

Approach, in which he theorized the Stakeholder theory.  

 

2.2 Stakeholder Theory  

The stakeholder theory offers a different view of businesses and their goals. It states 

that there are various constituencies that impact and are impacted by companies like 

employees, suppliers, local communities, creditors, investors, and others. Therefore, a 

firm should try to create value for all its stakeholders, not just for the shareholders. This 

is because the corporate environment functions like an ecosystem of interconnected 

groups, all of which must be taken into account and satisfied to maintain the company's 

long-term health and success.  



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The stakeholder view of strategy combines elements of both the resource-based and 

market-based views, incorporating an additional socio-political dimension. It does not 

only concentrate on profit-maximizing, but it also addresses morals and values in 

managing an organization, like those related to CSR, social contract theory, and market 

economy. 

This theory was first introduced by R. Edward Freeman in his book Strategic 

Management: A Stakeholder Approach (1984), in which he illustrates a comprehensive 

framework for managers to run a company in the current fast-evolving business 

environment. The book identifies all the different kinds of stakeholders and suggests 

methods on how to manage their interests. This is the difference between the 

stakeholder approach and the traditional way of doing business, the owners of the 

company are not anymore, the only important group to pay attention to and increase 

value for, now other parties are also involved and must be considered. The Stakeholder 

theory encourages managers to generate value and collaborate with both internal and 

external forces. 

Another important principle of the Stakeholder theory is the jointness of stakeholders’ 

interests. Even if it is impossible that the interests of all groups are satisfied at all times, 

managers should understand the relationships between the different stakeholders and 

look for an equilibrium between them. 

Stakeholder management requires an integrated approach to strategic decision-making. 

Instead of formulating strategies on a stakeholder-by-stakeholder basis, managers 

should strive to simultaneously satisfy multiple stakeholders. Successful strategies 

embrace the perspectives of all stakeholders rather than pitting them against each 

other. This approach acknowledges that not all constraints can be turned into win-win 

situations through detailed understanding, as stakeholders may not uniformly benefit. 

Despite a nuanced grasp of stakeholder relationships, strategies often entail both 

benefits and drawbacks for various groups. Ensuring long-term support from all 



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stakeholders requires developing strategies that balance harm distribution. Over time, 

cohesive management of stakeholder interests becomes essential. 

To sum up, when making a decision, business executives have to take into account the 

interest of all stakeholders, both internal and external, because they are critical for the 

long-term success of the company. The objective is to generate maximum value for key 

stakeholders and align the shared interests of seemingly disparate groups. Businesses 

can pursue a purpose beyond profit maximization, fostering collaboration among 

diverse stakeholders towards a common goal. 

However, some criticism arose also from this theory, for example, the political 

philosopher Charles Blattberg criticized the stakeholder theory for assuming that it is 

always possible to balance the interests of the various stakeholders and not create 

discord between them. He argues that stakeholders represent such a large and diverse 

group that is impossible to please them all, one or more stakeholders will have to take 

a backseat to others. 

Moreover, if allocating some of the corporation’s profits to various stakeholders 

contributes to the company’s long-term profits, it means that the firm has not traded 

off some of its profits in order to meet the needs of non-shareholding stakeholders, but 

rather, it has simply sacrificed some short-term gain for a long-term benefit. Therefore, 

meeting the needs of non-shareholding stakeholders has improved shareholder profit 

anyway. The final goals remain, then, the profit and this means that there is little 

significant difference between the shareholder and stakeholder approaches (Blattberg, 

2004). 

However, the stakeholder theory, viewed as stakeholder management, facilitates the 

integration of social demands and long-term value maximization (Crane et al., 2013). 

Given this perspective, the theory appears to be a robust theoretical framework to 

elucidate the emerging ideology that emphasizes the significance of investing in social 

responsibility as a means to maximize profits and surpass competitors in the long run. 



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Another theory that explains how sustainability is related to a firm’s financial success is 

the agency theory.  

 

2.3 Agency Theory 

Another theory regarding the contrasting relationship between company shareholders’ 

priorities and the company executives’ main concerns is called the Agency Theory. This 

theory was first cited by Alchian and Demsetz (1972) and Jensen and Meckling (1976) 

and it describes the relationship between managers (seen as agents) and shareholders 

(called principals), where principals hire agents to perform a service on their behalf. 

However, this relationship can rise some issues: managers and shareholders may have 

different goals, have different levels of risk aversion, and have an information 

asymmetry. For example, management might aim to expand a business into new 

markets, prioritizing short-term profitability and elevated compensation. However, a 

risk-averse group of shareholders, more concerned about long-term earnings growth 

and share price appreciation, may find this strategy unattractive. 

Therefore, the theory argues that it is necessary to restrain firm managers from using 

their power to maximize their own benefits instead of the ones of the firm, and this can 

be done through appropriate incentives and adequate monitoring. There are several 

suggestions to "reduce agency loss”, which is the cost to the shareholder that arises as 

a consequence of managers not acting in the best interest of the owners (Jensen & 

Meckling 1976). One of the best-known strategies is offering incentives to managers, 

such as giving them stock options and tying part of their compensation to shareholder 

returns.  

However, there is a concern that management might compromise long-term business 

growth in a bid to boost immediate earnings and their personal compensation. This is 

often evident in budget planning, where management lowers annual budget predictions 



19 
 

to meet performance targets. In response to such concerns, an alternative 

compensation plan has emerged, where executive pay is partially deferred and tied to 

long-term objectives. 

Agency theory does not have only implications for the company, but also for society. 

One of the significant challenges stemming from agency theory is a lack of 

accountability, as shareholders bear responsibility for the company's actions, while 

management is the decision-maker. This creates a scenario where a company can 

generate negative impacts on the environment and society without clear internal 

accountability. Furthermore, companies often seek to externalize costs to maximize 

profits, shifting environmental impact expenses onto others. These externalities 

contribute to sustainability issues as they affect people surrounding the company. 

Fortunately, there is a shift in shareholders' mindset as they increasingly recognize the 

impacts, risks, and opportunities associated with sustainability (Boffo & Patalano, 2020). 

Moreover, many studies, such as those by Shleifer and Vishny (1989 and 2000), highlight 

that agency problems can manifest through investment choices that do not maximize 

value. Additionally, ESG expenses are often viewed as a form of investment, as 

suggested by McWilliams and Siegel (2001). In the context of Environmental, Social, and 

Governance Practices (ESGP), the agency problem can be characterized as managers 

having the incentive to invest in ESG activities that may not align with shareholders' 

preferences and may not maximize their benefits. In general, managers may allocate 

more investments to ESG initiatives than the optimal amount for maximizing firm value, 

influenced by social pressure and/or altruistic motives.  

This occurs because ESG activities tend to be more advantageous for managers than 

shareholders. Managers incur minimal costs when investing in ESG activities, yet they 

personally benefit by building a reputation for promoting responsibility. Consequently, 

managers may advocate for overinvestment in ESG, potentially at the expense of 

shareholders. ESG investments, in this context, can be perceived as instances of agency 

conflicts between management and the firm's shareholders (Goss et al., 2011). 



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However, in line with the stakeholder, agency and information asymmetry theory, 

managers who reveal their ESG practices can mitigate the exposure of the company to 

future risks. This, in turn, creates value for investors and other stakeholders by fostering 

the sustainability of long-lasting business models. Numerous studies, including those by 

Lopatta et al. (2016), Hsu and Chen (2015), Fombrun and Shanley (1990), and Kim and 

Kim (2014), have explored the connection between Environmental, Social, and 

Governance (ESG) practices and agency costs. Their findings indicate that engaging in 

ESG activities helps decrease agency costs by significantly mitigating the information 

asymmetry between external and internal stakeholders. ESG disclosure is recognized as 

providing additional nonfinancial information for investors, creditors, and regulators. 

Consequently, higher levels of ESG engagement are anticipated to reduce the cost of 

debt, as increased information availability about the firm benefits creditors. 

In summary, the theories propose that a delicate balance must be struck between the 

potential financial benefits and drawbacks of ESG activities. Firms, however, should 

exercise caution to avoid overinvesting in ESG practices, as this could exacerbate the 

agency problem. 

To conclude, the interest in ESG and sustainability issues by shareholders, stakeholders 

and managers have increased in the last few years. More and more companies are trying 

to adapt to this trend by participating in social initiatives, getting certified, and reducing 

their carbon footprint.  

In the next chapter, the previous studies related to ESG-CFP and ESG-Financial Distress 

Risk (FDR) relationship are presented. In the past several years, the interest in corporate 

sustainability has increased and the number of firms that employ sustainability 

strategies and disclose environmental, social, and governance information continues to 

rise. However, the gain from investing in ESG activities are often not explicitly reflected 

in a firm's financial disclosure. Their benefits and costs typically do not appear distinctly 

in profit and loss statements, nor is their accumulated value or impact clearly outlined 

on balance sheets. However, due to the increasing societal pressure for companies to 



21 
 

engage in socially responsible practices, it is important to investigate whether ESG 

activities improve the profitability and the financial performance of a firm. For this 

reason, many researchers have investigated the impact of ESG elements on firms’ 

performance. This chapter illustrates the findings of some of these previous studies, 

which are, however, often different from each other, some show positive relationships, 

other negatives, and other non-decisive results.  

 

2.4 The link between ESG pillars and Corporate Financial Performance 

The relationship between Environmental, Social, and Governance Performance and 

Corporate Financial Performance (CFP) has been widely studied, and the majority of the 

research suggests a statistically significant positive correlation between the two 

variables. This finding is consistent with the theoretical expectations of a null to 

modestly positive link, as described by Benabou and Tirole (2010). Despite this positive 

correlation, the scale of this relationship is typically modest (Cohen, 1988; Rosenthal & 

Rosnow, 1991), with some studies finding no correlation, mixed results, or even a 

negative link (Xie et al., 2017; Velte, 2017; Bruna et al, 2021; Batae et al., 2021; Atan et 

al., 2018; Jyoti & Khanna, 2021; Damers et al., 2021). However, it is important to note 

that even a small change can have a significant impact in a globally competitive market 

(Friede et al., 2015).  

 

Moreover, the integration of Environmental, Social, and Governance considerations into 

corporate decision-making has gained significant traction in recent years, as a result of 

the growing recognition of their impact on not only the financial performance of 

companies, but also on the well-being of their stakeholders. The diverse nature of ESG 

initiatives has resulted in some stakeholders benefiting more from these sustainable 

initiatives, while others may experience reduced benefits or even be negatively 

impacted.  

 



22 
 

Given this, it raises the question of the alignment of investing in ESG activities with the 

two prevailing theories of corporate social responsibility: the shareholder theory 

propounded by Milton Friedman in 1970 and the stakeholder theory articulated by R. 

Edward Freeman in 2002. 

The shareholder theory argues that the primary purpose of a corporation is to maximize 

shareholder value, and that corporate social responsibility activities should only be 

pursued if they align with this goal. Conversely, the stakeholder theory posits that 

corporations have a broader set of obligations to all their stakeholders, including 

employees, suppliers, customers, and communities, and that these obligations should 

be balanced with the goal of maximizing shareholder value. 

As such, this raises the question of whether investing in ESG activities aligns with either, 

or both, of these theories. Many companies have adopted a hybrid approach, balancing 

the interests of shareholders and stakeholders by investing in ESG activities that not only 

improve the company's reputation and contribute to a more sustainable future, but also 

have the potential to generate long-term financial benefits, such as reducing costs and 

improving operational efficiency. Therefore, overall, these two theories may even not 

be as diametrically opposed as one may think, a middle ground can probably be found, 

where managers create shared value between the firm’s shareholders and a broader set 

of stakeholders including employees, suppliers, customers and communities (Huang, 

2021; Porter & Van der Linde, 1995; Porter & Kramer, 2011).  

 

However, despite significant research, a definitive answer regarding the relationship 

between ESGP and CFP and the profitability of ESG initiatives has not been found yet, 

but rather just fragmented insights that provide only partial understanding of an unseen 

larger picture. (Galbreath & Shum, 2012). In the following paragraphs, previous 

literature on the subject is presented and divided into three main categories: the 

research that observed a positive link, a negative link, and mixed/non-decisive results. 

 

 



23 
 

2.4.1 ESGP-CFP Positive Link 

Many studies have found a positive link between ESGP and CFP, proving the 

stakeholder’s theory and the benefit of a greener way of conducting business.  

For example, Garas and El-Temtamy (2020), observed that a higher and more objective 

environmental disclosure improves the firm financial performance. It also positively 

influences the firm’s market value and reduces the company’s market risk. To prove 

their hypothesis, they analysed 577 publicly listed companies from Bahrain, Kuwait, 

Oman, Qatar, Saudi Arabia, and UAE over a ten-year period (2008–2017). The sample is 

comprised of 4963 observations and all data have been acquired through the Bloomberg 

database, both for the financial information and for the ESG scores that have been used 

as a proxy to measure the CSR. They used accounting and financial measures such as 

return on assets (ROA) and Tobin’s Q, which is calculated as the market value of a 

company divided by its asset’s replacement cost, to evaluate the firm financial 

performance. A similar result was also obtained by A.W. Wirawan et al. (2020) who 

analysed listed companies in Hong Kong and found that CSR disclosures have a positive 

effect on firm value. However, the result may vary from country to country, especially 

between nations with very different laws and regulations.  

For US non-financial institutions, a study has been conducted by Atif and Ali (2021), 

which also found that environmental, social, and governance disclosure is positively 

related to Merton's distance to default. Merton's (1974) structural models utilize option 

pricing methods to compute a probability of default, relying on the level and volatility 

of the market value of assets. Within this framework, the strike price aligns with the face 

value of the firm's liabilities, as indicated by Bharath and Shumway (2008). A greater 

positive distance between the firm's value and its liabilities corresponds to a lower 

probability of default. Moreover, the authors also analyzed the relationship between 

ESG disclosure and credit default swap spread, they turned out to be negatively related. 

These results suggest that firms with a higher ESG disclosure have lower default risk. 

This is probably due to increased profitability and reduced performance variability and 

cost of debt. Though, this relationship seems to exist only for mature and older firms. A 



24 
 

possible explanation may be, as previous studies showed (Hasan et al., 2018; Ullmann, 

1985; Shaukat and Trojanowski 2017; McWilliams & Siegel, 2001), larger firms face 

greater scrutiny compared to smaller ones, therefore, they are expected to disclose 

more ESG information.  

Nevertheless, ESG disclosure may not reflect entirely the real environmental, social and 

governance efforts made by the companies. In fact, corporations are often guilty of 

greenwashing, pinkwashing or rainbow washing, and are not always completely 

transparent about their real policy and ESG actions (Boffo & Patalano, 2020; Kreca & 

Spitzer, 2022). For this reason, it is important to evaluate the corporates’ ESG 

performance also with external indexes calculated with real independent data.  

For instance, Trung et Vo (2023) used the Thomson Reuters ASSET4 to assess the firm’s 

ESG performance level. The Thomson Reuters ASSET4 is a comprehensive database for 

ESG performance that comprises data for many companies from all over the world. It 

offers measures of environmental performance, social performance, corporate 

governance, and economic performance that have been calculated independently. In his 

study, Do (2002) observed that ESGP is negatively linked with the probability of default 

and this relationship is stronger in the long term than in the short run. This happens 

because ESG activities, apparently, can improve access to external financing, reduce 

transaction costs and increase competitive advantages by enhancing customer loyalty. 

These results support the pay-off hypothesis, which assumes that the costs of ESG 

activities are marginal, and firms may profit from ESG actions in terms of employee 

morale, productivity, and attraction of new customers (Solomon and Hansen, 1985; 

Moskowitz, 1972; Shaukat & Trojanowski, 2017; Waddock & Graves, 1997). 

Another study by Lin Dong (2018) showed that companies with a strong track record of 

positive Corporate Social Responsibility engagement are less likely to file for bankruptcy 

when facing severe financial distress. Additionally, these firms are more likely to 

undergo a quicker and more effective recovery process from such financial challenges. 

Moreover, companies with high ESG score seems to be less likely to be in financial 

distress, as Boubaker et al.’s (2020) study found. In their paper, they examine the 



25 
 

situation of 1.201 US-listed firms during the period 1991–2012, recording their CSR level 

and their financial distress risk (FDR). The authors measured the CSR level using the MSCI 

ESG score and the FDR with Altman Z-Score (Altman et al., 2017) and Merton’s model 

(Merton, 1974). It seems like having a better ESGP gives firms more creditworthiness 

and better access to financing, which results in fewer bankruptcy cases. This correlation 

is more pronounced in companies with robust governance mechanisms and intense 

competition in the product market. The effect is heightened for less distressed firms and 

is particularly evident during non-crisis periods. 

Moreover, from the research of Rehman et al. (2020) and Chan et al. (2017), the financial 

performance of the businesses seems correlated with the firm’s ESGP. In both studies, 

they collected ESGP information from the MSCI database, but they used different 

measures for CFP. Rehman et al. (2020) used ROA to measure the firm financial 

performance, while Chan et al (2017) used KZ index scores and Altman’s Z-scores. 

Despite this and the different countries of the firms’ samples (US for the first article and 

Asian and European for the second one), the final results are similar: ESG positively 

impacts firm performance and negatively affects firm risk. These findings are also 

confirmed by Gangi et al. (2020) study, which also showed that the positive influence of 

CSR on the firms' financial performance which is more pronounced in SMEs than in large 

firms. Additionally, the research of Rehman et al. (2020), which examined data from 

companies listed on Fortune's Most Admired Countries for the period 2014–2018, also 

discovered that CSR has a significant positive influence on firm reputation and that firm 

reputation partly mediates CSR-performance relationship. 

Furthermore, according to Okafor et al. (2020), investing in ESG activities can also cause 

general growth for companies. In particular, the US tech companies that from 2017 to 

2019 spent the most on ESG actions have experienced a corresponding increase in 

revenue and profitability. The research demonstrates that as an organization allocates 

more resources to ESG activities, its overall value is positively impacted. Simultaneously, 

the study indicates that investments in ESG initiatives have a discernible influence on an 

organization's return on assets and stock value. 



26 
 

This may also be linked to the fact that ESG investing may also suggest innovation as 

Martinez-Conesa et al.’s (2017) research suggests.  

As we can see, the previous research has quite extensively analysed the ESGP-CFP 

relationship, however, not every research reaches the same positive results. Several 

studies have presented a contrasting perspective from what has been discussed thus 

far. In the following subchapter, we illustrate some of the articles that report a negative 

or not-positive link between the two variables.  

 

2.4.2 ESGP-CFP Negative link 

While many studies claim that ESG activities make the company more innovative and 

generate extra revenue that can cover the additional costs, and therefore, that CFP can 

be positively influenced by an appropriate ESG strategy, other empirical studies show 

that ESG and CSR initiatives bring additional costs caused by agency problems and 

ineffective resource allocation, which can put the firm in a bad position in the market. 

According to Batae et al.’s (2021) study, this could be partially true for European banks. 

In fact, despite observing a positive correlation between emission reductions and 

financial performance, the study found that an improvement in the quality of a bank's 

corporate governance system had a negative impact on CFP. This implies that corporate 

governance quality has a negative effect on accounting performance and market 

valuation, contradicting the expectations of agency theory. The study utilizes data from 

the Refinitiv database, covering 39 European banks over the period 2010-2019. To 

evaluate the ESG performance of the companies they used the ESG rates of the Refinitiv 

database using around 150 indicators that range across ten different areas. Then, to 

evaluate the corporate financial performance, the authors used three different 

variables: ROA, Return on Equity (ROE), and Tobin’s Q. The negative relationship found 

by this research could mean that banks’ actions in social responsibility initiatives are not 

taken into consideration by market investors and they do not endorse the adoption of 

best governance practices that could reduce the riskiness of a bank’s portfolio. In 

particular, the authors found that there is a significant negative relationship between 



27 
 

these ESG area and financial performance: the CSR strategy dimension and stock market 

returns (SMR); lagged product responsibility and ROA; the change in Soc_PRD and the 

change in ROA; corporate governance quality and SMR; the CSR strategy dimension and 

SMR and between the change in the management and oversight score and the change 

in ROA.  

Another report by Atan et al. (2018) investigates the relationship between companies’ 

ESG pillars and their financial performance in Malaysia. They noticed that there is no 

significant relationship between individual and combined factors of ESG and firm 

profitability (measured with ROE) as well as firm value (measured with Tobin’s Q). This 

non-existent correlation implies that companies that have high ESG initiatives may 

perform equally as well or as poorly as the ones that have low ESG rates. In addition, 

ESG is also not perceived as increasing firm value. These results may be caused by the 

short period spam analysed (2010-2013), since usually, the relationship between 

sustainability and financial performance is only significant in the long term and not in 

the short term as argued by Eccles et al. (2014). Moreover, the stakeholders in 

developing countries may have a lower interest in ESG activities as the ones in US or 

Europe. They still have to gain more confidence in the corporations’ ESG initiatives that 

could eventually lower their cost of capital, as found by Ming et al. (2013) and it is also 

true that ESG data may not be used extensively by the capital market in determining the 

cost of capital yet (Park & Jang, 2013). 

Similar results are found in the study of Jyoti and Khanna (2021) which investigates the 

influence of a firm's ESGP on the CFP of companies from the service sector listed on the 

Bombay Stock Exchange. The findings reveal a noteworthy negative correlation between 

the Environmental score and both Return on Assets and Return on Capital Employed 

(ROCE) for the sample companies. Conversely, only the Social score exhibits a significant 

negative association with ROE. Furthermore, the combined score for ESG also 

demonstrates a negative and significant relationship with both ROCE and ROA. 

Moreover, a recent article written by Damers et al. (2021) on the indicators of share 

price resilience during COVID-19 crisis, showed that companies with better ESG scores 



28 
 

did not experience greater returns during the pandemic, once industry relation and 

market and accounting factors of returns have been properly controlled for. They argue, 

on the other hand, that what could actually explain the price resilience during COVID-19 

of some stocks, is the firms’ investments in internally developed intangible assets. This 

suggests that the flexibility derived from a large stock of innovative assets was more 

important than the firm’s social capital during this global pandemic, at least for what 

concerned stock’s price resistance. This would mean that the claim that ESG is 

particularly valuable as a risk mitigation strategy and as a protection in periods of crisis 

is not true. However, this does not mean that in the long-run ESG investment does not 

create value for both shareholders and communities.  

Not all studies, though, offers a clear view on the relationship between CFP and ESGP. 

Several research papers show contrasting results. Some of those are presented in the 

following chapter.  

 

2.4.3 Non-decisive results 

Mixed results were found in the study of Xie et al. (2017) who used the Bloomberg 

Environmental, Social, and Governance Database and the DEA model to evaluate the 

relationship between ESG disclosure and corporate efficiency. The authors found out 

that a moderate level of ESG disclosure has a significant and positive effect on corporate 

efficiency, contrary to a high or low disclosure level. The strongest positive relationship 

is found for governance disclosure followed by social disclosure and environmental 

disclosure. A similar result can be found in another research conducted in Germany by 

Velte (2017) for the business years 2010-2014, which showed that the governance 

performance is the area that has the strongest impact on CFP.  

 In contrast, a low level of disclosure has a detrimental impact on corporate efficiency, 

with the exception of environmental information disclosure, which has shown a 

relatively weak positive relationship with corporate efficiency. A high disclosure level 

also negatively affects corporate efficiency, especially environmental disclosure. These 

results suggest that the relationship between ESG disclosure and corporate efficiency is 



29 
 

not a simple linear relationship. For example, the authors found a positive relationship 

between cost-cutting policies, such as green building, sustainable packaging, and 

environmental supply chain, and CFP. However, there were no significant results 

observed in the relationship between climate change policies and financial 

performance. However, no significant results are found between climate change policies 

and financial performance. For what regards social activities, firms that try to offer 

training programs equally and reduce demographic discrimination tend to outperform 

their peers. In terms of governance activities, an important role is played by 

independent directors in lowering agency costs and maximizing shareholder value, and 

this leads to better CFP. Including women on the board also have a strong positive 

relationship with financial performance. 

A non-linear relationship has also been observed by Bruna et al. (2021), which highlights 

the existence of a non-linear relationship between ESGP and CFP. For almost all the 

companies they analysed, a decreasing trend is observed in CFP up to a mid-value of 

ESGP, then, CFP shows a moderate increase. This means that ESG commitment is 

negatively associated with financial performance until a certain level of ESGP, after that, 

further efforts are recompensed with a partial improvement of financial results. 

Supporting that, Sahut and Pasquini-Descomps (2015), wrote that the function linking a 

stock’s performance to its ESG-score changes is probably non-linear. They came to this 

conclusion after measuring the monthly stocks’ changes performance over a five-year 

period for numerous US, Swiss and UK companies and their related news-based ratings 

in different ESG categories. They noticed a slightly positive relationship between ESGP 

and stock’s price only in UK companies and the results were highly dependent on the 

year and sector. 

This means that, even if the literature around ESGP and CFP link is widely spread, further 

analysis has still to be conducted to better understand the dynamics of that relationship. 

It is important to know if it changes from country to country and if it is influenced by 

firm industry or size or by any other relevant factor. For both investors and stakeholders, 

it is fundamental to know whether green investing is actually a profitable choice that 



30 
 

will bring them a higher value in the future. This study, therefore, aims to better analyse 

the link between ESGP and financial distress in European countries. 

  



31 
 

3. Hypotheses 

According to Baird (1987), bankruptcy occurs when a financially distressed firm is unable 

to meet its obligations, including repaying its due liabilities, and as a result, enters a 

collective proceeding to settle the competing claims of its creditors. Financial distress 

can arise from various sources, such as internal failure, industry decline, or economic 

distress (Wruck, 1990), including global financial crises and pandemics such as COVID-

19. The incidence of bankruptcy is influenced by economic cycles, with fewer firms 

facing financial distress during times of economic prosperity, and many firms 

experiencing difficulties due to external factors during periods of economic downturn 

(Wruck, 1990).  

The first question we try to answer in this paper, is whether ESG pillars may influence 

bankruptcy probability of the firm.  

Investments in environmental measures and sustainability can have a positive impact 

on a firm's financial performance by reducing the risk of reputation loss and increasing 

supply chain resilience. Liang and Renneboog (2017) argue that sustainable investments 

improve environmental performance, thereby reducing business risk. Additionally, 

sustainability investments can foster stability when dealing with emerging distress by 

promoting loyalty and reliability among stakeholders, especially suppliers 

(Vishwanathan et al., 2020). Moreover, consistent investments in social measures can 

enhance employee motivation and collaboration, leading to a decrease in the risk of 

internal failure due to higher management motivation and social awareness (De Roeck 

et al., 2016; Edmans, 2011; Scheidler et al., 2019). Furthermore, improving internal 

governance structures can increase transparency and enable early detection of potential 

distress situations (Cheng et al., 2014). Transparent structures can also decrease the 

possibility of poor and short-term-oriented management, thereby reducing the risk of 

distress (Vishwanathan et al., 2020). Transparent structures can also foster mutual trust 

among stakeholders, including banks, leading to improved access to financing for high 

ESGP firms (El Ghoul et al., 2017). These hypotheses are confirmed by Chan et al. (2017) 



32 
 

which confirm a significant negative association between CSR activities and the degree 

of financial distress. 

Based on the results of previous research, our first hypothesis aims to assess if there is 

a relationship between financial distress and ESG pillars in European listed companies. 

H1: A company with a high ESG performance is less likely to incur in bankruptcy the 

following years, this means that there is a positive link between ESG score and the 

Altman Z’’-Score. 

The second research question is whether there is an ESG pillar that influences the most 

the financial performance of the firms, this may be the environmental, social, or 

governance factor. Previous studies have shown different results, for example, Xie et al. 

(2017) found that governance disclosure has the strongest positive relationship with 

CFP, and a similar result can be found in the study conducted in Germany by Velte 

(2017). In the article of Jyoti and Khanna (2021), the authors write that while a significant 

negative relationship between the Environment score with ROA and ROCE is found in 

the selected companies, only the social score shows a significant negative association 

with the ROE. Moreover, as the research of Huang (2021) explains, the correlation may 

varies between the different ESG pillars and the CFP measures. For example, the 

Environmental factor usually has a stronger correlation with all type of CFP measures. 

Meaning that environmental investment may benefit more the financial performance of 

a firm than the social and governance ones. 

Therefore, according to the previous studies, the second hypothesis is the following: 

H2: The firms’ financial performance is affected in a different way by the environmental, 

social or governance pillars.  

  



33 
 

4. Data and Methodology 

The purpose of this chapter is to provide a thorough presentation of the data and 

methodology utilized in this research for the master thesis. The first section provides a 

description of the regression models applied to the sample, which will be used to test 

the research hypotheses. The second part outlines the process of data collection for 

European companies, along with an overview of the sample's characteristics. In the end, 

the Altman Z-Score formula and the ESG score used in the analysis are discussed in 

detail. 

4.1 Regression Model 

In this chapter, we will present a regression analysis to test the relationship between 

the ESG combined score and the Altman Z’’-score. The purpose of this analysis is to 

investigate whether there is a statistically significant correlation between these two 

variables, and to identify any potential control variables that may influence this 

relationship. In the next subsections we will explain and describe the variables included 

in the model. 

 

4.1.1 Regression Model 

𝐴𝑙𝑡𝑚𝑎𝑛 𝑍′′ − 𝑆𝑐𝑜𝑟𝑒𝑖,𝑡

=  𝛼 +  𝛽1𝐸𝑆𝐺𝑖,𝑡−1 + 𝛽2𝑆𝐼𝑍𝐸𝑖,𝑡 +  𝛽3𝑅𝑂𝐴𝑖,𝑡 + 𝛽5𝐿𝐸𝑉𝐸𝑅𝐴𝐺𝐸𝑖,𝑡

+ 𝐶𝑂𝑈𝑁𝑇𝑅𝑌𝑖 +  𝐼𝑁𝐷𝑈𝑆𝑇𝑅𝑌𝑖 + 𝑌𝐸𝐴𝑅 + 𝑒  

Where ESG is the ESG combined score; SIZE is the natural logarithm of total assets; 

ROA is the return on assets; LEVERAGE is long term-debt on total assets; COUNTRY 

is the GDP per capita; INDUSTRY and YEAR are dummy variables; ε is the error term. 

To assess the sensitivity of our results, we conduct additional analyses using 

different ESG score components, including the Environmental Pillar Score, Social 

Pillar Score, and Governance Pillar Score, to determine which ESG score has the most 

significant impact on corporate performance. Moreover, we examine whether the 



34 
 

effect of ESG investments takes longer to manifest by testing the model using ESG 

Combined Scores of the prior year, five years before, and ten years before. 

This study follows a quantitative research approach, similar to the methodology 

employed by Habermann and Fischer (2021). The choice of this approach aligns with 

the study's objective, which is to examine the influence of ESG scores on bankruptcy 

probability. The quantitative research method enables the exploration of potential 

relationships between variables and the derivation of meaningful conclusions from 

the results (Saunders et al., 2016). However, it is crucial to acknowledge certain 

limitations associated with quantitative research. One primary constraint is its 

potential to exclude significant in-depth knowledge that cannot be easily translated 

into quantifiable forms (Choy, 2014). 

The multiple regression model chosen is the Ordinary Least Squares (OLS), following 

the example of Habermann & Fischer (2021). Multiple regression analysis is a widely 

accepted statistical technique that allows us to examine the simultaneous influence 

of multiple independent variables, such as various ESG components and time 

frames, on our dependent variable, which is corporate financial performance. 

We chose multiple regression analysis because it provides a rigorous and systematic 

approach to assess these relationships, controlling for potential confounding factors. 

This method allows us to quantify the impact of different ESG components and 

assess whether certain time frames are more critical for companies seeking to 

improve their financial performance. 

By employing this method, we aim to provide robust empirical evidence on the link 

between ESG performance and corporate financial performance. We believe that 

this approach will enable us to identify which specific ESG components and time 

frames are more significant for companies looking to enhance their financial 

performance. This methodological choice aligns with the goal of our study, which is 

to contribute valuable insights to the field of corporate sustainability and finance,  

 



35 
 

4.1.2 Dependent Variable 

Altman Z’’-Score 

The Altman Z-Score will be used to calculate the bankruptcy probability of firms 

(Habermann & Fischer, 2021; Altman et al., 2017). Following the methodology of ), 

Magnanelli et al. (2017) ,  Erragragui (2018) and Sengupta (1998) a lag time effect of one 

year, five years and ten years is applied between the dependent variable and the 

independent variable of ESG rating. This is attributed to the assumption that alterations 

in firms' ESG actions are likely to yield an impact over an extended period rather than 

having an immediate effect.. We expect the ESG Score to have a positive relationship 

with the Altman Z’’-Score, therefore the higher the ESG company’s performance the 

better its financial situation.  

 

4.1.3 Independent Variables 

ESG Combined Score 

Refinitiv ESG score will be used to assess the environmental, social and governance 

performance of the firm. A high ESG score means that the company is performing well 

under that aspect. This study has chosen the ESG score of Refinitiv Eikon as it is the most 

trusted data source of ESG metrics (Batae et al., 2021). ESG Combined score of Refinitiv 

is widely used by researchers in their studies (Ioannou and Serafeim, 2012; Shakil et al., 

2019; Eccles et al., 2014; ; Batae et al., 2021; Bae et al., 2021). 

This metrics is discounted for significant ESG controversies impacting the corporations, 

for this reason it will be equal or lower then the normal ESG Score, as we can see in the 

Figure 16. 

Environmental Pillar Score 

In order to better understand if any ESG has a different influence on the financial 

performance of the firm, we will conduct three different regression analyses with which 

one of the ESG scores. The first one is the environmental score that measures the effect 



36 
 

that a firm has on the environment, it consists of three categories that are resource use, 

emissions, and innovation (Refinitiv, 2022). 

 

Figure 1. Environmental pillar score matrix 

 

Social Pillar Score 

The social score evaluates the interaction between the firm and its employees, 

customers, and society, assessing the firm's capacity to generate shareholder value 

through trustworthiness and reputation. This score is further categorized into four 

aspects: workforce, human rights, community, and product responsibility, offering a 

comprehensive examination of the company's social performance (Refinitiv, 2022). 

 

Figure 2. Social pillar score matrix 

 

 

 



37 
 

Governance Pillar Score 

The governance score serves as an assessment tool for evaluating a firm's performance 

in corporate governance matters. It scrutinizes the firm's management and reporting 

processes to ascertain that leadership aligns with the best interests of the firm's owners. 

Within the Refinitiv database, the governance score is subdivided into three categories: 

management, shareholders, and CSR strategy. (Refinitiv, 2022). 

 

Figure 3. Governance pillar score matrix 

In the following graph we can see the evolution of the different ESG pillar scores from 

2011 to 2021. The scores illustrated in the table are calculated yearly as the average of 

all available scores. 

 

Figure 4. Evolution of ESG scores from 2011 to 2021. 

 

40

45

50

55

60

65

70

2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

ESG trends

ESG combined score Enviromental Score

Social Score Governance Score



38 
 

4.1.4 Control Variables 

In the regression analysis we control for other factors that have been identified as 

significant determinants in past research (Kabir et al., 2020; Kabir et al., 2021, Nadarajah 

et al., 2020; X. Zhang et al., 2020; Baboukardos & Rimmel, 2016; Erragragui 2018; Cheng 

et al. 2014; Kang et al., 2021, Wang and Qian, 2011; Habermann & Fischer, 2021). 

Size 

In alignment with prior research methodologies, firm size is quantified using the natural 

logarithm of total assets, as demonstrated in studies by Baboukardos and Rimmel 

(2016), Erragragui (2018), and Cheng et al. (2014). The transformation to logarithm is 

employed to address distributional normality issues associated with the variable, as 

noted by Setó-Pamies (2015). Controlling for firm size is crucial, as evidenced in earlier 

studies such as Goss et al. (2011), which indicate that larger firms exhibit lower risk 

compared to their smaller counterparts (Magnanelli et al., 2017; Benlemlih and Girerd-

Potin, 2017). Aoudadi and Marsat (2018) asserted that company size has been directly 

linked to company value, but there is no agreement on whether company size has a 

positive or negative impact on firm value. Conversely, Alareeni and Hamdan (2020) 

discovered that company size has a positive influence on CFP. 

ROA 

Another proxy of financial performance is the return on assets. Return on Assets (ROA) 

serves as a profitability ratio, assessing a company's return on investment. It specifically 

measures a company's operational efficiency independently of its financial structure, 

irrespective of the degree of leverage employed by the company. The calculation 

involves dividing a company's net income before financing costs by its total assets (Wang 

& Qian, 2011). We use ROA as a control variable to assess whether the Z-Score is a 

reliable proxy for financial performance. ROA is expected to have a negative impact on 

the firm's default risk and therefore to be positively correlated with the Altman Z-Score. 

Firm-level data on ROA were collected from Refinitiv database. ROA has been used 

frequently for measuring firms’ financial outcomes in ESG research (Kang et al., 2021, 

Wang and Qian, 2011; Kabir et al., 2021). 



39 
 

Leverage  

Leverage is defined as the ratio of the sum of long-term debt to book assets (Kabir et al., 

2021). Leverage amplifies the companies’ financial risk and is expected to exhibit a 

positive relationship with default risk. Scholars highlight that debt has a significant 

impact on the behavior of managers. On one hand, debt serves as a disciplinary 

mechanism, motivating managers to make decisions that align with the organisation's 

best interests. On the other hand, the restraints imposed by debt, reducing managerial 

flexibility, can limit opportunities for exploring new business ventures, potentially 

having a negative impact on profitability. The debt ratio represents the fraction of a 

company's assets that are funded by debt. If the ratio is higher than 1, it indicates that 

the company has more liabilities than assets, which poses a risk of default if interest 

rates increase abruptly. In essence, a high debt ratio implies that a significant portion of 

a company's debt is supported by its assets. We use debt ratio as a proxy for companies’ 

leverage and management’s risk tolerance. Drawing from existing studies, Waddock and 

Graves (1997) posit that a company's attitudes toward risk activities can yield savings, 

incur both present and future costs, and impact its market position by either enhancing 

or diminishing it. However, it's acknowledged that all firms inherently bear some level 

of risk, and occasionally embracing risks, such as increasing debt, might ultimately 

enhance a firm's profitability and value, as noted by Brealey, Myers, and Allen (2011). 

Industry  

According to Ruf et al. (2001), previous studies provide evidence that financial 

performance differs across industries. Controlling for industry is crucial, as firms within 

a specific industry need to satisfy similar types of stakeholders and respond to their 

demands more effectively than competitors. This suggests that stakeholders and their 

expectations can differ between industries, leading to variations in both financial and 

sustainability performance. Waddock & Graves (1997) and Setó-Pamies (2015) also 

suggest that the type of industry might influence sustainability behavior. Failing to 

control for different industries might obscure the main effects of overall differences in 

sustainability performance. Therefore, we used a sector (TRBC Business Sector Name) 



40 
 

as a control variable, employing a dummy variable to differentiate sensitive (Utilities, Oil 

and Gas, and Basic materials) and non-sensitive (all others) industries (Tarquinio et al., 

2018).  

Country 

Gross Domestic Product (GDP) per capita is a metric used to gauge a country's economic 

output, taking into consideration its population size. It is often used as a proxy for the 

level of economic development of a country or region. Given that the factors influencing 

corporate ESGP should encompass macroeconomic considerations (Gillan et al., 2021), 

this study draws on previous research (Ren et al., 2023; Apergis et al., 2022; Eliwa et al., 

2021; Li et al., 2018). It utilizes GDP per capita (PGDP) as a measure of economic 

development and incorporates economic policy uncertainty to account for variations 

across countries (Ren et al., 2023). 

Year 

To control whether the Covid-19 has influenced the financial performance of the firms 

we use the year as a dummy variable. Therefore, we consider “1” the years 2020 and 

2021 and “0” all the others.  

  



41 
 

4.2 ESG pillars 

Companies are under increasing pressure to “do good”, meaning to operate not only for 

their financial gain but also in order to help the communities and the environment, or 

at least, to not damage it. However, despite the society increasing attention on this 

manner and the decades of academic research, there is still a significant gap in 

understanding how ESG is considered, the motivations behind its adoption, which are 

the benefits, who benefit from it and where it might lead. 

By environmental, social, and governance criteria we mean a set of standards to 

evaluate a company’s non-financial performance. Environmental criteria assess how a 

company fulfills its role as a steward of nature. Social criteria scrutinize how it handles 

relationships with employees, customers, suppliers, and the communities in which it 

operates. Governance encompasses a firm’s leadership, executive compensation, 

audits, shareholder rights and internal controls (Investopedia, 2022). 

In the figure below we can see how the CFA Institute (2022) defines these three 

concepts: 

Figure 5. ESG pillars (CFA Institute, 2022) 

However, there is not a standard definition for ESG pillars, and, therefore, there is no 

standardized method to measure them either. Different companies and websites 

provide an ESG rating for businesses. An example is the MSCI ESG Rating which is one of 

the most widely referenced ESG rating systems. It scores about 8,500 firms and more 

than 680,000 fixed income and equity securities worldwide, including ESG funds. The 



42 
 

MSCI ESG score measures risk across 10 categories of environment, social, and 

governance areas and rates the companies on a scale from leader (AAA, AA), average (A, 

BBB, BB) to laggard (B, CCC). This rate employs a rules-based methodology to identify 

industry leaders and laggards based on their exposure to Environmental, Social, and 

Governance risks and their proficiency in managing those risks compared to their peers 

(MSCI, 2022). 

Other indicators are the KLD-index, the Dow Jones Sustainability Index and the ASSET4. 

The latter has a leading role in providing objective, comparable and auditable non-

financial information about publicly listed firms. Unlike KLD, ASSET4 does not eliminate 

firms in “sin” industries, which are involved in, for example, alcohol, tobacco, or defence 

and focuses on more preeminent firms. In this thesis, we will use the Refinitiv rate, since 

their database offers one of the most complete ESG databases covering over 6,000 

public firms, across more than 400 different ESG metrics, with a history going back to 

2002.  

The Thomson Reuters ESG Scores are designed to measure firms’ ESG performance 

transparently and objectively across ten areas (emissions, shareholders, environmental 

product innovation, human rights, etc.) based on company-reported data. The score 

grades go from a D- to A+ and are also available in percentages. The ESG score used is 

the one called “Thomson Reuters ESG Score” which measures firms’ ESGP based on 

company reported data in the public domain (corporate website, annual reports, ESG 

reports, bylaws, code of conduct, etc.) across ten categories as illustrated in the Figure 

6 (Refinitiv, 2022). 

To calculate the 11 categories, a percentile rank scoring methodology is adopted. It 

relies on ranking and is consequently not highly responsive to outliers. The distribution 

of scores produced with the percentile rank score is nearly uniform. As a result, the 



43 
 

average and standard deviation of the scores derived from the percentile rank score are 

not particularly informative. 

Figure 6. Refinitiv ESG score (Refinitiv.com, 2022) 

Each category score is determined by the equally weighted sum of all the indicators used 

in its creation. Normalized weights are calculated, excluding indicators with no available 

data in the public domain. The number of measures within each category determines its 

weight. The overall ESG Score is derived as a weighted average of the underlying 10 

category scores (Refinitiv, 2022). Additionally, each score can be translated in a grade 

that goes from D- to A+, as shown in the pictures below. 

 

Figure 7. Refinitiv ESG score formula 



44 
 

 

Figure 8. ESG score quantiles 

 

 

Figure 9. ESG Grades 

In this thesis we will use the Refinitiv ESG Combined Score as an indicator of ESGPThe 

The ESG Controversies (ESGC) score is computed as the weighted average of the 

Environmental, Social, and Governance (ESG) scores and ESG controversies score for 

each fiscal period, with recent controversies impacting the latest completed period. 

Therefore, where companies are not entangled in ESG controversies, the ESGC score is 

equal to the ESG score. The ESG controversies score is computed based on 23 ESG 

controversy topics. Throughout the year, if a scandal occurs, the implicated company is 

penalized, affecting its overall ESGC score and grading. The impact of the event may 

persist into the following year if there are new developments in the negative event, such 



45 
 

as fines, lawsuits or ongoing legislative disputes. All new media materials are taken into 

consideration as the controversy progresses. Additionally, the controversies score 

addresses the market cap bias that large-cap companies may face, adjusting scores 

based on a firm’s size to mitigate the disproportionate media attention larger companies 

receive compared to smaller ones. The calculation of these ESG scores is well explained 

in the figures below. 

 

Figure 10. ESG Score categories 

 

 

Figure 11: Refinitiv ESG scoring methodology 

However, there are some limitations in ESG ratings, for example, as Berg et al. (2019) 

explained in their paper, there is a divergence between many of the most common ESG 



46 
 

ratings. Their results show that ESG rating discrepancy is not only a matter of different 

definitions but a fundamental disagreement about the underlying data. Some of this 

difference is explained by the fact that those different rates do not have the same view 

on which categories are most important in ESG evaluation, however, Measurement 

divergence is an issue when considering that ESG ratings should ideally rely on easily 

discernible and objective observations. The authors also found the main differences in 

the following categories:  Corporate Governance, Climate Risk Management., 

Environmental Management System, Product Safety, and Corruption and that the 

disagreement between ESG scores is even more marked in specific sub-categories. 

Another problem in ESG rating is that there is a so called “rater effect”, which means 

When a rating agency assigns a positive score to a company in one category, there is a 

tendency to do the same in other categories as well. 

4.3 The Altman Z-Score 

Many bankruptcies prediction models have been developed over time, some are 

univariate models, or risk index models, others are conditional probability models, some 

use market-based data, and others accounting-based information. Despite the perfect 

model does not exist yet and that each one’s efficacy may vary from country to country 

or between industries, many have proven to be quite effective. In this chapter, we will 

briefly illustrate some of them and then concentrate on the Altman Z-Score (Altman, 

1986), which is still a widely used tool to predict bankruptcy or financial distress both in 

research and in practice (Altman et al., 2017). 

Despite what someone may think, the history of credit scoring models dates back to the 

1800s when money lenders needed to have information about the lender’s credibility. 

The first credit reporting agencies were small, local merchants’ associations that over 

the years developed into bigger and more structured companies that sold borrowers’ 

info to banks (Point Editorial, 2022). In the 19th century, then, the importance of credit 

scoring rose together with the growing market of loans. Suddenly, information about 

creditability was crucial and needed to be more accurate and not subjective, this is when 

the rating system took steps toward a quantitative analysis. The approach used for 



47 
 

bankruptcy prediction has evolved over time and it was in 1983 that Altman proposed 

that the management of distressed firms can employ the Z-Score model as a tool for 

guiding financial turnaround. 

However, one of the first to accurately predict the bankruptcy probability of a company 

was Beaver (1966, 1968). He used univariate analysis to research the relationship 

between financial ratios and firm financial distress. His study scored an important 

academic advancement since he demonstrated that financial ratios could be used to 

foresee financial distress before it happens. This opened the path for further research 

on this matter. One of these was, in fact, the research of Edward I. Altman, a Professor 

of Finance at New York University's Stern School of Business who theorized the Altman 

Z-Score. 

Another model is the one developed by James Ohlson in 1995 (Ohlson, 1995) called the 

Ohlson O-score. The model is based on the idea that a company's value can be divided 

into two components: the value of its assets and the value of its earnings power. The 

Ohlson O-score is calculated using a combination of financial ratios that measure a 

company's asset value and earnings power, such as the price-to-book value ratio and 

the price-to-earnings ratio. Companies with an Ohlson O-score below a certain threshold 

are considered to be at high risk of bankruptcy. 

Moreover, the Springate model, which was developed by Philip Springate in 2002 

(Muzanni & Yuliana, 2021), is based on the idea that bankruptcy risk is determined by a 

combination of financial and non-financial factors. The Springate model offers a score 

to a company depending on its level of risk after identifying the characteristics most 

closely linked to bankruptcy risk using multiple regression analysis. Companies are 

regarded as having a high risk of bankruptcy if their score is higher than a specific level. 

This model uses multiple regression analysis to identify the factors that are most 

strongly associated with bankruptcy risk and assigns a score to a company based on its 

risk level. Companies with a score above a certain threshold are considered to be at high 

risk of bankruptcy. Similarely, the Zmijewski model introduced by Mark Zmijewski in 

1984 (Zmijewski, 1984) use a multiple regression analysis to identify the financial ratios 



48 
 

that are most strongly associated with bankruptcy risk and assigns a score to a company 

based on its risk level. 

Overall, failure prediction models were relevant at the time as much as they are now. 

They are important tools for investors, bankers, asset managers, rating agencies, and 

even distressed firms. Banks, for example, since are the main provider of financing in 

the economy, need bankruptcy prediction models to minimize the level of non-

performing loans (Altman et al., 2017) and also in order to meet the requirements of the 

Basel Accords which limits the bank's exposure to non-performing loans and securities 

(Said, 2013). Investors, on the other hand, need an efficient model to minimize their risk 

and maximize their profits. This means that it is important both for investors and banks 

to find a reliable accounting-based model to analyse the firms’ financial performance 

and the Z-Score model has become a prototype for many of these models. 

The Altman Z-score has been widely used as a financial distress risk indicator in the 

literature. For example, Apoorva (2019) found that the model was 85% accurate and 

effective for three years prior to the occurrence of the event of bankruptcy for 

companies listed on the Bombay Stock Exchange. Hou (2018) also used the Altman Z-

score to predict financial distress for listed companies in Taiwan and found that it 

performed well compared to other models. 

While the Altman Z-score is primarily used as a financial distress risk indicator, it has also 

been used in the literature as a measure of financial performance. For example, one 

study (Luo, Wang, & Zhang, 2015) found that the Altman Z-score was positively related 

to a company's financial performance, as measured by return on assets and return on 

equity. Another study (Liu & Zhang, 2023) found that the Altman Z-score was significantly 

correlated with a company's profitability, as measured by net income and net profit 

margin. 

However, the relationship between the Altman Z-score and financial performance is not 

always straightforward. Some studies have found that the relationship between the two 

is non-linear, with companies in the middle range of Z-scores having the highest financial 

performance (Kwok et al., 2014). Additionally, the relationship between the Altman Z-



49 
 

score and financial performance may vary depending on the industry and other factors 

(Gao et al., 2015). 

4.3.1 Classic Altman Z-Score Model 

The Altman Z-Score (Altman, 1986) is a statistical model developed in 1968 for 

evaluating the financial health of listed companies. In his study, the author tested 22 

possible ratios on a sample of sixty-six companies both bankrupt and non-bankrupt, to 

find which were the most appropriate ones to predict financial distress. Most of the 

companies were manufacturing firms with an asset size that ranged from $1 million to 

$25 million, this is why this first theorized Z-Score Model is mostly used for listed 

companies in the manufacturing industry. This multiple discriminant analysis model 

(MDA), which uses the five best-performing ratios over the 22 ratios sample, is the 

following: 

Z-Score = 1,2A + 1,4B + 3,3C + 0,6D + 1,0E 

Where:  

A = working capital / total assets. This is the liquidity index. It measures how much 

working capital can be generated using the company’s assets. The value tends to 

decrease under crisis conditions. The working capital is calculated as current assets 

minus current liabilities. 

B = retained earnings / total assets. It measures the ability of a firm to self-financing, 

that is of investing the income gained (totally or partially) in new business projects. This 

ratio determines how much earnings can be generated using the assets and the ability 

of earnings to compensate for the total assets. This is a profitability indicator. 

C = earnings before interest and tax / total assets. This index measures returns on any 

type of invested capital (risk or financial investment) in the business. 

D = market value of equity / total liabilities. This ratio indicates the strength of the 

company in repaying its debts with equity capital. Market value can be found by 



50 
 

multiplying the number of shares outstanding by the common stock price, this value is 

therefore available only for listed companies. This is a solvency indicator. 

E = sales / total assets. This parameter calculates the ability of total assets to generate 

earnings, it is also called the asset turnover ratio. 

A company is considered safe when the Z-score is above 2,99 and in distress when is 

under 1,81 (Altman, 1968).  The author introduces the concept of a "grey area" or 

"uncertainty area" characterized by a Z-score falling between 1.81 and 2.99. Within this 

range, making a definitive assessment of the company's operating difficulties, whether 

inherent or potentially leading to default, becomes challenging. Further data and 

information are deemed necessary to classify the company clearly into either of the two 

aforementioned groups (Celli, 2014). 

Altman’s model is a widely used tool, not only for its easy application and interpretability 

nature but also for its accuracy (Qiu et al., 2020). In a previous study, Begley et al. (1996) 

estimated that the correctness rate was about 78%, while a recent article has shown an 

overall success rate of 87,3% in Italian companies in the year before economic failure 

and of 66,6% three years before it (Celli, 2014). The effectiveness of the Altman Z-Score 

for US-listed companies has also been tested many times, and, for example, Alkhatib 

and Al Bzour (2011) found an accuracy rate of 95% one year prior to default, of 83% two 

years prior to default and at 62% three years prior to default. The success rate, however, 

seems to vary between countries, for example, in Finland, the success rate is about 78% 

for private manufacturing firms (Lindstedt, 2019), while for companies quoted on the 

Greek market the rate was 66% one year before and only 52% two years prior 

bankruptcy (Gerantonis, Vergos, & Christopoulos, 2009). For companies listed on the 

Jordanian market, the accuracy rate of the model differs, as indicated by Alareeni and 

Branson (2013): the Z-score effectiveness has been evaluated at 87% one year prior to 

default, 94% two years prior to default, and 89% three years prior to default. 

The main limitation of this model is the fact that it was proven to be reliable only for 

manufacturing companies, quoted in the market, and with assets over 1$ million. This is 



51 
 

why Altman later developed other versions of the same Z-score model to adapt it to 

different types of industries and to private companies. 

 

4.3.2 Altman Z’-Score and Z”-Score Models  

Since the original Z-Score model l relied on the market value of the firm, it was initially 

applicable solely to publicly traded companies, Altman over the years continued to 

reevaluate his model and to upgrade it to make it more comprehensive. From 1969 until 

1975, he analyzed 86 firms in distress, then 110 from 1976 to 1995, and finally 120 from 

1996 to 1999, discovering that the Z-score had an accuracy of between 82% and 94%. 

In 1983, Altman created two other models to investigate smaller private manufacturing 

companies, and then in 2012, he developed 

 an updated version called the Altman Z’’-score that can be used to evaluate public and 

private companies, manufacturing, and non-manufacturing companies, and U.S. and 

non-U.S. companies. In this model, he substituted the market value of equity with the 

book value of equity in D. 

The Altman revised Z’-Score model is: 

Z’-Score = 1,717A + 0,847B + 3,107C + 0,430D + 0,988E 

where D = Book value of equity/Book value of total liabilities, with the other variables 

the same as those in the original (1968) Z-Score model.  

The Altman Z’’-Score Model, instead, is: 

Z’’-Score = 6,56A + 3,26B + 6,72C + 1,05D 

This model omits the Sales/Total assets ratio (E) in the revised version due to the 

potential influence of industry effects, especially when incorporating an industry-

sensitive variable such as asset turnover (Altman et al., 2017). The turnover ratio is 

expected to be notably higher for retail and service firms compared to manufacturing 

firms. Consequently, utilizing the original model to predict bankruptcy in non-



52 
 

manufacturing firms could result in underestimating the risk, given their lower capital 

intensity (Hodge & Hughes, 2010). 

In this research, I will use the Altman Z’’-Score to evaluate the financial performance of 

the companies’ sample since it has the widest scope, it is intended for both privately 

held and publicly listed firms and for both manufacturing and non-manufacturing firms. 

 

4.4 Data collection and description 

The data for this research is acquired through Refinitiv database. Refinitiv Eikon is one of the 

world's largest providers of financial markets data and infrastructure, serving over 40,000 

institutions in about 190 countries. The balance sheets and the financial data provided by the 

databases are used to apply the Altman Z-Score. ESG variables will then be investigated by 

using the Refinitiv ESG Combined Score.  

The initial data set retrieved covers data on European publicly listed companies over a life 

span of 10 years, from 2011 to 2021, and consists of 26740 firm-year observations. However, 

from the initial sample, all the companies with missing data have been eliminated, resulting 

in 9880 observations. Following the example of previous research (Viale et al., 2002; 

Brav, 2009; Eliwa et al., 2021; Kim et al., 2014), we also excluded financial institutions due to 

their unique capital structure,  different treatment of leverage and regulation applied. The 

final sample is therefore composed of 9422 observations with 1740 different companies. 

As we can see from the following table, in the sample about 5077 companies are ESG positive, 

meaning with a score equal to or over 50 (A+, A, A-, B+, B, B-), while the remaining 4345 do 

not follow sustainability standards well enough (D-, D, D+, C- rate). 

 Table 1. ESG sample distribution 

 

 

Number of firms ESG Combined Grade ESG Combined Score

1032 A from 100 to 75

4045 B from 75 to 50

3434 C from 50 to 25

911 D from 25 to 0

https://link.springer.com/article/10.1007/s10551-021-04956-4#ref-CR11
https://link.springer.com/article/10.1007/s10551-021-04956-4#ref-CR46


53 
 

 

The table below provides a comprehensive overview of the financial health of the sample 

companies, as measured by their Altman Z''-Score. As shown in the table, the majority of the 

firms (44,7%) fall within the safe zone, with an Altman Z''-Score of greater than 3. This 

indicates that these companies have a low risk of bankruptcy and are financially stable. 

However, it is also noteworthy that a considerable number of companies, namely 2980, fall 

within the distress zone, indicating a high risk of bankruptcy. Additionally, 2225 companies are 

in the grey zone, which implies that they are at moderate risk of bankruptcy and require close 

monitoring. 

 

Table 2. Altman Z’’-Score sample distribution 

 

 

The companies analysed in this paper have their headquarters in Europe, specifically in 33 

different European countries, as the following table shows. Previous research in this area has 

often focused on US-listed companies or singular countries, for instance, Alareeni and 

Hamdan (2020) conducted a study examining the impact of ESG pillars on the performance of 

US firms listed on the S&P 500. However, given the growing importance of ESG considerations 

in the global financial landscape, it is crucial to investigate the relationship between ESG 

scores and financial performance for European companies as well. This will provide a more 

comprehensive understanding of the impact of ESG pillars on corporate financial performance 

in a global context. 

 

 

 

 

 

Number of firms Z-score

4217 Safe Zone >=3

2980 Distress Zone <=1,8

2225 Grey zone



54 
 

 

Table 3. Country distribution of the sample 

 

The United Kingdom accounts for the largest proportion of the sample, with 2544 companies 

or approximately 27% of the sample. Germany and France are the next most represented 

countries, with 978 (10.4%) and 842 (8.9%) companies respectively. A significant number of 

firms in the sample are also from Sweden, Switzerland, Spain, Italy, the Netherlands, and 

Ireland, each accounting for more than 3% of the sample. Other countries represented in the 

sample include Portugal, Hungary, and Ukraine, which account for smaller propo