THE ROLE OF ENVIRONMENTAL, SOCIAL, AND GOVERNANCE (ESG) IN PREDICTING FINANCIAL DISTRESS CASE OF KSA

Abstract

This study explores the potential of environmental, social, and governance (ESG) metrics in predicting financial distress in Saudi Arabian industries over an eleven-year period from 2012 to 2022. We start by defining what financial distress is. Financial distress occurs when a company is unable to meet its financial obligations due to insufficient earnings or income. Our research shows that incorporating ESG metrics enhances the capability to identify financial distress. Using ESG data reduces the likelihood of misclassifying struggling or delinquent industries as financially stable. We employ the Z score model to identify industries with a high risk of failure and examine how ESG factors influence a company's performance and impact the investors' decision-making. Our results demonstrate that industries with lower ESG scores are more likely to experience financial distress, while industries with higher ESG scores are more likely to remain financially stable over time. Moreover, we found that ESG metrics can provide valuable insights into a company's risk exposure and potential for long-term financial sustainability. The implications of our study extend beyond the Saudi Arabian context and have broader relevance for investors and policymakers seeking to assess the financial health and sustainability of companies across different industries. Our findings highlight the importance of incorporating ESG metrics into financial analysis and decision-making processes, particularly in the context of emerging markets where companies may face higher levels of environmental and social risks.