Default risk in the era of environmental, social and governance ratings: a comparative analysis of divergence

We investigate the effect of environmental, social and governance (ESG) ratings and their divergence on default risk. Using a sample of Chinese A-share listed firms from 2009 to 2022, we find a negative relationship between default risk and ESG performance, suggesting that better ESG performance could lower default risk for firms. Moreover, ESG rating divergence weakens this negative relationship. Several robustness tests, addressing endogeneity concerns and using alternative default risk measures, confirm the validity of this finding. In addition, the marginally inhibiting effect of ESG ratings and rating divergence on default risk is more noticeable in companies that have low market competition, low audit quality and high levels of financial constraints and that belong to industries with high pollution. This paper highlights the importance of including ESG factors in investment strategies as well as the significance of transparency and standardization in ESG rating methodologies for promoting transparent and robust financial markets.