Impact of Governance Quality on Default Risk of Socially Responsible Firms: International Evidence

Research Question: Default risk problem is more prevalent during the recent covid-19 pandemic era, stopping economic activity, hurting firms, and exposing them to default risk but governance and CSR may lower this default risk problem. Motivation: As a result of the research work of Altman (1968), researchers have given great attention to the determinants of firms’ default risk. Previous studies (Asis et al., 2021; McGuinness et al., 2018) mostly focus on the link between leverage and default risk, our study introduces governance quality and CSR into the debate as new factors that may mitigate default risk of firms. Idea: This paper investigates the impact of governance quality on default risk of socially responsible firms from developing countries. Data: Governance quality data are obtained from the World Governance Indicators. The firm-level data are obtained from the DataStream databases. We use a total of 466 listed firms from 15 developing countries and cover 2010 to 2017 periods. Method/Tools: The two-step system generalized method of moments is applied to mitigate endogeneity problem. Findings: Governance quality (i.e., rule of law) has a significant negative impact on firms’ default risk in the full sample and three regional sub-samples (i.e., Asia, Africa and Middle-East, and Latin American Countries). The results suggest that strong governance quality appears to minimize bankruptcy costs which lower default risk of socially responsible firms in developing countries. Contributions: Unlike prior studies that focus more on the relationship between leverage and default risk and use single country dataset, this study focuses on the impact of governance quality on default risk of socially responsible firms, and thus contributes to an extensive body of theoretical and empirical work that focuses on firms’ default risk. Secondly. this paper covers three regions (i.e. Asia, Middle East and Africa, and Latin America regions) to improve the validity and robustness of our conclusion.