Circularity and Default Probabilities: an empirical investigation based on the 3R principles

This paper empirically investigates the role of Circular Economy (CE) in explaining firms' probability of default (PD) in the short and the medium term. Based on the 3R principles of CE, we identify three main dimensions of circularity whose mean represents an overall circularity score. The first, Reduce, measures the degree of reduction in GHG emissions with respect to the previous year, the second, Reuse, measures the share of renewable energy used and the third, Recycle, measures the share of waste recycled or recovered. We adopt and OLS regression over a sample of 108 European companies, from the STOXX Europe 600 Index over the period 2017 – 2021. Three main results emerge. First, both in the short and medium term circularity practices are associated to a lower PD even after accounting for usual economic – financial indicators. Second, among the three dimensions of circularity the really relevant one is Reduce. Third, when comparing the effect of circularity in the short term versus the medium term, it emerges that the negative relationship with the PD is more pronounced in the short term, suggesting that immediate benefits of CE (e.g. tax benefits, easier access to credit, better reputation) offset implementation costs, which instead can be amortized over years. These results are of interests both for managers, who may exploit the negative association of CE and PD, and for supranational institutions that via circularity regulation may also contribute to a more stable financial system.