Integrating ESG into financial distress models: The role of financial report quality and innovation in the Chinese market

Abstract

This study evaluates how financial report quality and innovation modulate the impact of Environmental, Social, and Governance (ESG) factors on financial distress. It draws on a comprehensive dataset encompassing 3,959 A-share listed companies from the Shanghai and Shenzhen Stock Exchanges over the period from 2012 to 2022. We choose data on ESG factors sourced from Bloomberg and CSMAR databases. Financial distress was assessed using Altman’s Z-score and O-score. To measure innovation, the study employs Mergers and Acquisitions (M&A) activity and Research and Development (R&D) expenditures as proxies. Financial report quality was gauged using the absolute value of discretionary accruals, which served as moderators in analysing the impact of ESG on financial distress. After the empirical analysis, the findings indicate that ESG factors contribute significantly to reducing financial distress among firms. Furthermore, both financial report quality and innovation were found to enhance the effectiveness of ESG practices in mitigating financial distress. This suggests that high-quality financial reporting and robust innovation practices can strengthen the protective effects of ESG initiatives against financial instability.