The modified ESG-KMV model for default prediction

This study enhances credit risk assessment by incorporating environmental, social, and governance (ESG) factors into the KMV model. Using matched data from 110 Taiwanese companies, half of which experienced financial crises between 2015 and 2023, we propose adjusting the KMV model’s default threshold on the basis of ESG ratings. This approach calculates ESG-adjusted default distance and expected default frequency (EDF), providing a more comprehensive evaluation of corporate credit risk beyond traditional financial indicators. The empirical findings show the following: First, incorporating ESG factors significantly widened the default probability gap between crisis and noncrisis companies. Second, ESG inclusion enhances the logit model’s explanatory power—each 1% increase in EDF with considering ESG ( ) increases the probability of financial distress by 2.210 times. Third, ESG factors improve model prediction accuracy, particularly for early warning. Finally, robustness tests confirm model stability.

Authors

Institutions

Publication Details

Journal
International Review of Economics & Finance
Published
2026-03-17
DOI
https://doi.org/10.1016/j.iref.2026.105117
Primary Topic
Financial Distress and Bankruptcy Prediction
Type
article
Field-Weighted Citation Impact
0.00
Controls
|||
ALL TIME
JAN
FEB
MAR
APR
MAY
JUN
JUL
AUG
SEP
OCT
article

The modified ESG-KMV model for default prediction

Yun-Ting Lin, Chia-Chien Chang, Chih-Yuan Yang
International Review of Economics & Finance
Financial Distress and Bankruptcy Prediction
article

The modified ESG-KMV model for default prediction

Yun-Ting Lin, Chia-Chien Chang, Chih-Yuan Yang
article en

Abstract

This study enhances credit risk assessment by incorporating environmental, social, and governance (ESG) factors into the KMV model. Using matched data from 110 Taiwanese companies, half of which experienced financial crises between 2015 and 2023, we propose adjusting the KMV model’s default threshold on the basis of ESG ratings. This approach calculates ESG-adjusted default distance and expected default frequency (EDF), providing a more comprehensive evaluation of corporate credit risk beyond traditional financial indicators. The empirical findings show the following: First, incorporating ESG factors significantly widened the default probability gap between crisis and noncrisis companies. Second, ESG inclusion enhances the logit model’s explanatory power—each 1% increase in EDF with considering ESG ( ) increases the probability of financial distress by 2.210 times. Third, ESG factors improve model prediction accuracy, particularly for early warning. Finally, robustness tests confirm model stability.

International Review of Economics & FinanceVol. 107
Dayeh University (TW), National Taiwan Normal University (TW), National Kaohsiung University of Science and Technology (TW)
Openalex Percentile: Top 18%
Financial Distress and Bankruptcy Prediction
AI Navigator

Ask Laika to Summarize, Analyze, and Connect papers live on the map.

Summarize Papers & Methodologies

Extract key findings, datasets, and comparative methods across publications.

Benchmark Rankings & Visual Analytics

Rank top research institutions, authors, funders, topics, and journals by Field-Weighted Citation Impact (FWCI) and paper volume with instant charts.

Connect Distant Disciplines

Bridge topological clusters on the map to find hidden collaborative intersections.