Quantitative easing and default probability of corporate social responsibility in US

ABSTRACT

The US Federal Reserve’s quantitative easing (QE) policies lowered the cost of servicing corporate debt and enhanced firms’ ability to borrow. This article seeks to improve the accuracy of default probability calculations as proposed by Merton (1974) under conditions of lower interest rates resulting from QE. By modifying the long-term debt ratio, we find distance to default is undervalued. Specifically, we find that the distance to default is more stably for firms with excellent corporate social responsibility (CSR) performance, but those with poor CSR performance are significantly undervalued. Our results show that improved CSR performance correctly estimates the firm’s default risk, even during QE when the Federal Reserve’s balance sheet expanded by nearly $4.5 trillion.

KEYWORDS:

• Quantitative easing
• distance to default
• corporate social responsibility
• Merton model

JEL CODES:

• E43
• G12
• G34

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ Since 1991, Kinder, Lydenberg, Domini Research & Analytics (KLD) use a firm’s social performance data to determine the relative strength of a given firm’s social performance. KLD rates firm CSR performance based on seven main categories (i.e., community, corporate governance, diversity, employee relations, environment, human rights, and product quality) and 80 sub-categories. In this study, we used the KLD social performance rating scores as our measure of CSR performance.