The Role of Circular Economy in Reducing Corporate Default Probability: Insights from Recent Research

Circular economy (CE) practices significantly enhance financial performance by increasing resource efficiency, reducing costs, and bolstering corporate reputation. By reducing waste and maximizing resource use, companies can decrease costs and improve operational efficiency, thus directly enhancing their financial health. CE practices such as emission reduction and resource recycling not only lower production costs but they also mitigate regulatory and environmental liabilities, leading to a direct decrease in credit risk and an improvement in corporate financial stability. Within this frame, the integration of digital technologies has transformed traditional business models into more agile and efficient circular e-business models. These advancements facilitate real-time resource flow optimization, scaling CE practices effectively across global supply chains, thereby enhancing companies’ Environmental, Social, and Governance (ESG) performance and reducing their credit risk by lowering default probability. Moreover, government structures and firm characteristics like size and ownership significantly influence the effectiveness of CE practices. Small and Medium-sized Enterprises (SMEs) often face unique challenges in implementing CE due to their concentrated ownership structures and short-term needs. However, strong governance frameworks can help overcome these barriers by ensuring robust resource management and fostering a culture of sustainability. In conclusion, by adopting CE strategies such as waste reduction, product life extension, and closed-loop supply chains, firms can significantly enhance their ESG profiles, increasing investor confidence and lowering the cost of capital. Companies with high circularity scores, reflecting comprehensive adherence to CE principles and strong ESG performance, have been shown to have a reduced default probability compared to less sustainable counterparts.