“Zombie” Companies: Background and Policy Issues

“Zombie” Companies: Background and Policy Issues

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October 29, 2020
“Zombie” Companies: Background and Policy Issues
“Zombie” companies are mature companies that have not
any given year. Accordingly, the BIS definition makes clear
generated sufficient profits to cover their debt borrowing
that a company is not a zombie merely because it is
costs over a period of years. Such companies are
unprofitable. Rather, zombies must demonstrate sustained
characterized by prolonged underperformance and poor
unprofitability and poor future prospects.
future prospects and are often associated with low
productivity. The number of zombie companies has gone up
What Is the Harm?
in recent years. As many as 15% of companies in the
One of the main economic concerns regarding zombie firms
Russell 3000—an index of 3,000 publicly traded U.S.
is low productivity, which in turn can lead to low economic
companies that make up the vast majority of the investable
growth. Because zombie companies’ profits cannot cover
public U.S. equity market—are considered zombies by
their debt servicing costs, they generally cannot invest in
some (Figure 1). This In Focus addresses basic questions
future growth through activities such as research and
about zombie companies, discusses their effects on the
development. Zombies can also tie up capital and labor,
economy, and briefly reviews policy implications and
preventing them from being allocated toward higher-growth
proposals to address them.
opportunities. They are therefore viewed as inhibiting
creative destruction, a term first introduced by economist
Figure 1. Percentage of U.S. Zombie Companies in
Joseph Schumpeter in the 1940s to refer to the process in a
Russell 3000 Equivalent Index
free economy in which insolvent companies are destroyed
to make room for other healthier and more productive
companies.
While the methods to keep zombies afloat vary, some
observers believe that unless such methods can provide a
fundamental cure for low productivity and profits,
temporary fixes merely delay insolvency. Furthermore, as
zombies proliferate, they could become financial stability
concerns: If economic conditions deteriorate or interest
rates rise, zombies may file for sudden bankruptcies with

effects that cascade throughout the broader economy.
Source: Leuthold Group and Joe Rennison, “Pandemic Debt Binge
Creates New Generation of Zombie Companies,” Financial Times,
Why Have Zombies Proliferated During
September 13, 2020.
the Pandemic?
Notes: Companies with profits that are less than the interest paid on
The number of zombies has increased in recent years,
their debts for at least three years. Data based on the Leuthold 3000
including during the Coronavirus Disease 2019 (COVID-
Universe (a Russel 3000 equivalent) as of September 2020.
19) pandemic (Figure 1). Factors that may have contributed
to the formation of new zombies include reduced profits at
When Is a Company a Zombie?
pandemic-affected businesses and improved credit
Definitions of zombie company can vary. Unprofitable
conditions, including low interest rates, easy availability of
companies are not automatically zombies. For example,
funding, and direct government intervention. In addition,
companies facing temporary earnings challenges, such as
existing zombies are remaining in their zombie status for
young growth companies or companies that are going
longer, likely because fewer zombies than expected have
through a restructuring phase, are generally not considered
taken exits through bankruptcies and takeovers.
zombies. The Bank for International Settlements (BIS), an
international financial institution for central banks, offers a
Government interventions that improved funding
broad and a narrow definition of the term. The BIS’s broad
conditions. Government interventions in response to the
definition encompasses firms that have interest-coverage
pandemic have supported the survival of many companies,
ratios below one for at least three consecutive years and are
including zombies. For example, the pandemic triggered a
at least 10 years old. The narrower definition incorporates
corporate debt market meltdown in March 2020. Borrowing
these screening criteria but excludes firms with certain
became prohibitively expensive, and new corporate bond
financial characteristics that place them in the upper half of
issuances came to a near standstill. The U.S. Federal
their industries in a given year. Specifically, the ratio
Reserve and the Treasury Department provided historic
between the market value of a firm’s assets and their
support to credit markets , including unprecedented steps to
replacement cost (the sum of the market value of equity and
agree to purchase corporate bonds and bond exchange-
liabilities divided by the sum of the book value of equity
traded funds. Following direct capital market interventions
and debt) must be below the median for the firm’s sector in
and fiscal support from Congress, corporate borrowing
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“Zombie” Companies: Background and Policy Issues
costs dropped (Figure 2). New bond issuances not only
zombie firms may not necessarily lead to the arrival of new
recovered but boomed. Corporate bonds set a new annual
and higher productivity firms .
issuance record in September 2020. Many observers view
these interventions, together with the Fed’s low interest rate
Figure 3. Zombie Companies’ Employee Headcount
policies in the years leading up to the pandemic, as having
(Top 10 Industries)
had the unintended consequence of keeping heavily
indebted zombies alive.
Figure 2. Corporate Bond Costs and Selected Federal
Reserve Emergency Program Announcement Dates

Source: Arbor Research and Jeff Cox, “Highly Indebted Zombie
Companies Control More Than 2 Mil ion U.S. Jobs,” CNBC, May 20,
2020.
Policy Proposals
Faced with a mixture of economic and social demands,

many observers have suggested a range of policy proposals
Source: Steven Sharpe and Alex Zhou, “The Corporate Bond
for zombies. They include the following:
Market Crises and the Government Response,” FEDS Notes, October
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3, 2020.
Exclude zombies from government support. This idea
Notes: Spread of corporate bond yields over Treasury yields.
appears straightforward, but some say it faces
Movements in Intercontinental Exchange Bank of America option
implementation challenges. Complex program
-
adjusted yield spreads for U.S. investment
requirements aimed at identifying and excluding
-grade (left) and high-yield
(right) bonds around the onset of COVID
zombies may affect program costs and implementation
-19 crisis. PDCF and
SMCCF are Federal Reserve emergency lending programs.
efficiency. Furthermore, by appearing to pick winners
and losers, such measures may draw charges of
government interference with the free market.
Fewer bankruptcies than expected. Calculations from the
American Bankruptcy Institute, a trade association that
 Direct government support to workers instead of
compiles bankruptcy data, reportedly show that Chapter 11
companies. Instead of providing financial support for
filings at the parent company level are 28% lower for the
companies, some proposals call for direct support to
initial pandemic period (from March 1 to September 30,
workers. They suggest government support through
2020) compared with the same period a year earlier. By
well-designed active labor market policies to help
contrast, the bankruptcy rates during the 2007-2009
displaced employees find work rather than passive
financial crisis were much higher than average. Some
measures that focus on financial benefits. By directly
experts attribute the lower-than-expected number of
targeting workers, the government programs would
bankruptcy filings to government support, including the
avoid the appearance of picking winners and losers.
small business Paycheck Protection Program; a certain
Such support would permit workers to leave zombies for
amount of rebound in business activity; and forbearance by
more productive employers.
landlords, lenders, and suppliers.
Policy Issues and Potential Solutions
 Grants instead of loans. Government assistance in the
form of loans would require interest and principal
While zombies have the potential to lower productivity and
payments that might only sustain zombies. Grants,
economic growth, the extent of such harm and the policy
however, may have more potential to resolve zombies’
solutions to address it are complex issues for debate.
debt burdens and kick-start their ability to invest in new
Social Costs of Creative Destruction
initiatives.
Some observers argue that the negative effects of zombies
 Recapitalization plans. Recapitalization proposals call
are overstated. These commentators view zombies as
for government to buy shares of equity of zombies on
important sources of employment. If zombies can cover
behalf of taxpayers . As alternatives to loans, they would
their operating costs and contribute to employment, they
not increase borrowers’ debt burden but would grant
suggest, that is a positive. Zombie companies are reportedly
taxpayers with ownership stake in zombies. These
responsible for more than 2.2 million U.S. jobs (Figure 3).
proposals are more popular in Europe.
Subject to changing economic conditions, zombies may
fail, but allowing them to fail all at once may exacerbate a
 Insolvency regimes. Some proposals call for
crisis and pose financial stability concerns. Some experts
streamlining the bankruptcy process or other relevant
also argue that zombie companies provide on-the-job
insolvency regimes so that zombies’ assets can be
training to empower the workforce. Moreover, some
quickly transferred to potentially more productive uses.
economic research suggests that the disappearance of
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“Zombie” Companies: Background and Policy Issues
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IF11673
Eva Su, Analyst in Financial Economics

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