The impact of ESG ratings on financial distress : a study of the aviation industry

Abstract

Environmental, Social, and Governance (ESG) criteria have gained significant attention in the literature in recent years. This research aims to investigate the impact of ESG on financial distress risk for the airline industry. Additionally, the study distinguishes between low-cost and full-service airlines, acknowledging potential variations in their business models. The sample comprises of 45 airlines all over the world for the time period of 2009 through 2021. The empirical evidence shows that the ESG score has a negative relationship with the Altman-Z score thus increasing the financial distress risk. However, when extended into the moderating factor of full-service or low-cost, the findings differ. Low-cost airlines benefit from a higher ESG score with it decreasing the likelihood of financial distress. Additionally, during the COVID-19 pandemic, ESG ratings become less influential, and the relationship between profitability and financial distress risk has gained more importance. The implications of this research extend to managers, shareholders, and regulatory bodies. Managers should carefully evaluate the potential impact of ESG investments on financial risk, considering the limitations in passing costs to consumers. Shareholders consider the agency cost and problems regarding the rating agency's divergence of ESG scores. Regulatory authorities should focus on addressing issues like greenwashing and work towards establishing standardized ESG rating frameworks. These findings underscore the complexities involved in incorporating ESG considerations into financial risk assessment and management practices.