So-called zombie companies have been on the rise since the Global Financial Crisis and there are fears that the pandemic will only aggravate the problem. There are concerns that these firms — neither dead nor fully alive — will drain resources from the economy, slowing the recovery and dampening already sluggish productivity growth across most OECD countries, including New Zealand.
Virtually non-existent 30 years ago, by 2019 the number of zombie companies in advanced economies accounted for 13 percent of the total, according to the Bank of America Merrill Lynch. These companies have enough resources to continue to operate but are not generating sufficient profit to service their debts over an extended period. As CNN describes them “Zombie companies are usually heavily indebted, cannot pay down the principal on their debt, depend on low interest rates to meet loan interest payments, and are unable to restructure to become more profitable because their debt is dragging them down.”
What is behind the rise of the zombies?
Research from the Bank of International Settlements identifies two reasons for the increase in zombie firms over the last two decades. The first is that banks, struggling with their own balance sheets following the GFC, had been less likely to allow firms go bankrupt. Just-profitable zombie firms contributed to Japan’s “lost-decade” in the 1990s when Japanese banks rolled over loans to otherwise insolvent borrowers, with large costs to their productivity.
Secondly, and more importantly, historically low interest rates have enabled firms to continue to pile on more debt and just manage to afford the financing costs. Not only are there more zombie firms today, but zombies are surviving for longer than in the past with less pressure to reduce debt and cut back activity.
COVID19 suspends natural firm turnover
The pandemic has extended the cycle of low interest rates for the foreseeable. This plus relaxed credit policies, debt hibernation and wage subsidies are likely to support zombie firms much longer than might otherwise have been the case. While the pandemic is an unusual situation, recessions are not and are often viewed as necessary to clean out firms that don’t have a viable future and to allow new, vibrant firms to emerge.
In New Zealand liquidations have been declining for the last 5 years but reached an all-time low last year. Corporate insolvencies declined 23 percent in the second quarter of 2020 which suggests there may be struggling companies out there who are being artificially propped up by benign lending practices and government support.
Why do zombie companies hurt the economy?
Zombie companies are less productive than healthy companies which means they have an outsize impact on productivity growth, according to an OECD study in 2017. They stifle more productive firms by tying up workers and resources who would otherwise be employed by more productive firms.
In the US zombie companies are estimated to control 2.2 million jobs and have built up $2 trillion of debt over the pandemic, nearly $500 billion higher than the peak of the Great Recession. These are not just small firms either, with an analysis by Deutsche Bank Securities identifying nearly one in every five publicly traded U.S. companies as a zombie, double the number in 2013. They include iconic brands such as Macy’s, Boeing, Carnival, Delta Air Lines, Exxon Mobil and Marriott International.
Many of the new zombie companies are from industries hit hardest by the pandemic restrictions: travel and hospitality and retail. The top 5 sectors in the US that contain the walking dead by employee headcount according to Arbor Research are:
Industrial conglomerates: 233,000
Hardware, storage, and peripherals: 193,000
Energy equipment and services: 185,000
Hotels, restaurants, and leisure: 153,000
Too large to fail?
According to the OECD study, the likelihood of a firm being a zombie tends to increase with size. This might be because those firms are more likely to attract government subsidies, particularly in times of crisis when governments fear the impact of large numbers of employees losing their job. Zombie firms also tend to be older, being disproportionately represented in firms more than 40 years old.
One of the legacies of the pandemic will be the huge increase in global corporate debt but even in 2019 the IMF was sounding the alarm about the zombie corporate debt which it estimated amounted to $19 trillion or 40 percent of all corporate debt.
Business failures are tragic for the business and all those affected, but sometimes they are good for society. The government and Central Bank in New Zealand were right to step in to protect businesses and workers unfairly impacted by the closed border and physical distancing requirements. But some of these businesses will struggle to ever fully recover. Keeping non-viable companies’ afloat crowds out resources for new businesses that are more likely to grow and raise New Zealand’s already poor productivity and GDP in the future.