The influence of green innovation on default risk: Evidence from Europe

Abstract

This paper examines the relationship between green innovation and default risk using a sample of 26,904 firm-year observations across 35 European countries from 2003 to 2019. We find that green innovation is negatively related to firms' default risk, proxied by the market-based probability of default and accounting-based Altman's Z’‘-score and Zmijewski's ZM-score. The results are robust using an OLS fixed-effect regression and an alternative two-step GMM analysis to exclude the possibility of reverse causality. We also find that the mitigating effect of green innovation on default risk is more significant in market-oriented countries than in bank-oriented countries. However, such a mitigating effect loses significance in IPO firms. Finally, the investigation of firm risk channels shows that the mitigating effect is mainly driven by improved profitability and market value rather than reduced leverage channels. As the first study on the link between eco-innovation and credit risk, the present study's findings provide valuable guidance for the policymaker, corporate managers, investors, and other stakeholders.