Do environmental, social, and governance practices affect financial distress and performance? Evidence from Latin American firms

Abstract

This study examines the impact of environmental, social, and governance (ESG) performance and its three pillars on financial distress (FD) in Latin American firms from 2011 to 2022. It also investigates whether the interaction between ESG performance and FD affects firm performance (return on assets [ROA]). The existing literature shows important limitations in understanding the relationship between ESG practices and FD. Although some studies have examined these constructs separately, empirical evidence integrating both remains scarce, particularly in emerging economies. Moreover, no studies were identified that simultaneously analyze these effects within the Latin American context, revealing a substantial gap that this research aims to address. We employ a multilevel regression model estimated by maximum likelihood (ML), using a sample of 963 firms, comprising 11,724 firm-year observations. This approach allows us to control for firm-specific, country-specific, and temporal effects, providing robust evidence on the ESG, FD, and performance nexus. Findings indicate that ESG is positively associated with FD in models excluding lagged FD, but this relationship becomes negative when lagged FD is included, a pattern consistent across all ESG pillars. While ESG positively affects ROA, this relationship reverses when interacting with FD, reflecting the short-term costs and long-term benefits of ESG adoption. This study contributes to the literature by demonstrating how ESG practices influence FD and firm performance in emerging markets. It provides valuable guidance for managers, investors, creditors, regulators, and other stakeholders, showing that ESG investments can reduce financial vulnerability, improve access to cheaper financing, and enhance corporate reputation. The findings underscore the strategic role of ESG as a tool for risk mitigation and long-term value creation in Latin American firms.