How can firms' transition to a low-carbon economy affect the distance to default?

The transition to carbon neutrality by 2050 is a challenge for EU firms. The increasingly stringent regulation and required technological change in the context of environmental demands by firms’ stakeholders and civil society may compromise the viability of high carbon emitters. This study analyzes the impact of environmental performance on default risk as firms advance to low-carbon production (LCP), considering the moderating effect of stranded assets and innovation. For a sample of listed firms from 16 European countries from 2005 to 2019, our results indicate a greater distance to default for better carbon performers that are more advanced in their transition to LCP. Furthermore, default risk is lower when tangibility decreases and a firm has an active role in innovation activities, these effects being amplified for good carbon performers. Our results are robust to the use of alternative proxies for default risk, stranded assets, and innovation.