N°3 - 2022

Quarterly column 3 – Aprile 2022

“Zombie firms”. Scopri la terza quarterly column a cura del centro di ricerca applicata BAFFI Carefin

Scopri la terza pubblicazione delle Quarterly Columns on Capital Markets, i commenti periodici di EQUITALAB che trattano approfonditamente specifici argomenti in ambito finanziario con l’obiettivo di raggiungere un pubblico ampio, non solo accademici, esperti e studenti.


Introduzione a cura di Stefano Caselli e Stefano Gatti


Growing corporate debt and the zombie company effect

The Covid-19 pandemic has hit already undercapitalised and excessively leveraged European companies hard. As a result of the lockdowns in the spring of 2020, demand plunged for many businesses and their sources of earnings dried up. At the same time their costs increased, as their productivity and capacity dropped due to containment measures, supply chain disruptions and generalised uncertainty.

Due to the liquidity drains and the erosion of equity capital caused by the major economic shock associated with the pandemic and its containment measures, unprecedented monetary, fiscal and prudential policies were needed to help firms cope with the crisis and protect jobs. The ultimate aim was to prevent otherwise solvent firms from shutting down or going bankrupt.

More specifically, national governments’ interventions included direct financial support in the form of grants, as well as guarantees for loans and moratoria from bankruptcy and loan repayments. These measures have proved crucial to preserve favourable credit market conditions, support bank lending to businesses and prevent a wave of insolvencies of otherwise viable and productive firms.

However, while all these relief measures provided vital support to the economy and ensured the survival of many businesses in the short term, given the emergency, they did not explicitly intend to separate viable firms from non-viable ones, or to address the impending erosion of the companies’ equity base. On the contrary, coming in the form of debt, all these measures multiplied corporate indebtedness (see Figure 1), raising default risk in the medium term (Crouzet and Tourre, 2021) and potentially deterring firm investment (Hennessy et al.,2007; Demmou et al., 2021) and slowing the pace of economic recovery (Kalemli-Ozcan et al., 2018).

Therefore, the same policy measures may have supported not just otherwise viable firms, but also firms that cannot sustain their business over time but continue operating, artificially kept alive by cheap credit and debt forbearance – i.e., zombie companies. This has in turn raised the question about a rise in zombification in the euro area economy, which could constrain the post-pandemic recovery.

According to Helmersson et al. (2021), 3.4% of companies in the euro area qualified as zombies even before the pandemic started. Bear in mind that the existence of a few zombie companies is physiological, because of frictions in credit markets or bankruptcy courts, and might be even beneficial in the short term because avoiding bankruptcy prevents layoffs and protects input markets. But major growth in corporate zombification is potentially very dangerous in the medium term.

In a smoothly-functioning economy, capital should flow towards more productive uses at the expense of less productive ones. A rich body of literature dating back to Hopenhayn (1992) has shown that the exit of low productivity firms and the reallocation of their resources to more productive firms are the keys to aggregate multifactor productivity and ultimately economic growth.

In a seminal paper on the Japanese stagnation during the 1990s, Caballero et al. (2008) show that zombie lending, which can be generalized to a manifestation of inefficiencies in the firms’ exit margins, slows down such productivity-enhancing capital reallocation, reducing corporate restructuring and delaying recovery.

More specifically, zombification leads to market congestion and inefficient capital allocation, which weighs on aggregate productivity growth. The reason for this is that zombie lending reduces the flow of bank credit available to more productive firms, and healthy firms compete with de-facto subsidized zombie firms in the input and product markets. Such negative spillovers on healthier firms in turn can eventually translate into lower economic outcomes such as employment, productivity, innovation, investment and sales growth.

This argument finds its theoretical roots in Hayek’s seminal theory of business cycles, which identifies the misallocation of capital during periods of low rates as the main culprit for recessions. In addition, Myers’ debt overhang theory asserts that excessive debt negatively affects firms’ investment and employment.

Most recently, it is Acharya et al. (2021) who fully model the adverse economic externalities and the negative spillovers on healthier firms imposed by zombie lending and show how this delays economic recovery from crises and can potentially result in permanent output losses.

Empirically, this finds support in a large number of recent papers focused on zombie lending during the European sovereign debt crisis, which show that the spillover effects of providing credit to non-viable companies can be substantial. A more numerous presence of zombie companies is associated with a slower recovery and a deterioration of the relative performance of healthy firms (Storz et al. 2017; Adalet McGowan et al., 2018; Blattner et al., 2018; Andrews and Petroulakis, 2019; Schivardi et al., 2017). More specifically, in Europe, Acharya et al. (2020) find that non-zombie companies experienced a reduction of their investment rate between 7% and 24% depending on the industry, and an employment loss between 3% and 11%. All this was due to the presence of zombie companies in the years following the sovereign debt crisis.

In addition, increased corporate zombification also poses medium-term risks to the financial system. If the credit risk of zombies is not properly priced, banks, governments and investors will be left exposed should the viability of these companies be challenged following unexpected adverse shocks, a weak recovery or an unbalanced withdrawal of policy support measures.

Looking ahead, high levels of corporate debt by historical standards can be an obstacle to economic growth (Brunnermeier and Krishnamurthy, 2020). What’s more, European policymakers are called to face complex tradeoffs between continuing to provide support to firms to minimize unwarranted bankruptcies and save jobs, containing fiscal cost and encouraging resource allocation toward the firms that are more productive. Tackling the risk of zombification is already an onerous task. For European companies to recover,  alternative types and sources of funding will be required to help mitigate their mounting debt burden.

AFME (2021) estimates that €324 billion of the debt in the EU is unsustainable, of which 57% is attributable to SMEs. The resulting equity gap according to AFME is around €1 trillion, or 2-3% of the European gross domestic product (Ebeke et al., 2021).

The objective of this column is to update the estimates about the recapitalisation needs of European firms to critically discuss what has been done so far and propose new policy measures to preserve business continuity, reduce corporate indebtedness and fill the equity funding gap.

Assessing the health of the European corporate sector and understanding the size and distribution of the equity injections required to rebalance companies’ capital structure is not only timely but also of the utmost importance in designing policies going forward.


Per continuare nella lettura, scarica la quarterly column.

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