EC HH The Rise Of Zombie Companies — And Why It Matters

The Bank of International Settlements (BIS) has warned again of the collateral damages of extremely loose monetary policy. One of the biggest threats is the rise of “zombie companies.” Since the “recovery” started, zombie firms have increased from 7.5% to 10.5%. In Europe, Bof A estimates that about 9% of the largest companies could be categorized as “walking dead.”

What is a zombie company? It is — in the BIS definition — a listed firm, with ten years or more of existence, where the ratio of EBIT (earnings before interest and taxes) relative to interest expense is lower than one. In essence, a company that merely survives due to the constant refinancing of its debt and, despite re-structuring and low rates, is still unable to cover its interest expense with operating profits, let alone repay the principal.

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This share of zombie firms can be perceived by some as “small.” At the end of the day, 10.5% means that 89.5% are not zombies. But that analysis would be too complacent. According to Moody’s and Standard and Poor’s, debt repayment capacity has broadly weakened globally despite ultra-low rates and ample liquidity. Furthermore, the BIS only analyses listed zombie companies, but in the OECD 90% of the companies are SMEs (Small and Medium Enterprises), and a large proportion of these smaller non-listed companies, are still loss-making. In the Eurozone, the ECB estimates that around 30% of SMEs are still in the red and the figures are smaller, but not massively dissimilar in the US, estimated at 20%, and the UK, close to 25%.

The rise of zombie companies is not a good thing. Some might say that at least these companies are still functioning, and jobs are kept alive, but the reality is that a growingly “zombified” economy is showing to reward the unproductive and tax the productive, creating a perverse incentive and protecting nothing in the long run. Companies that underperform get their debt refinanced over and over again, while growing and high productivity firms struggle to get access to credit. When cheap money ends, the first ones collapse and the second ones have not been allowed to thrive to offset the impact.

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Gary Anderson 4 months ago Contributor's comment

Interesting view. But isn't the growth of debt essential to the expansion of the economy and to the expansion of the money supply? After all, mass shrinking of debt will lower the money supply as lending withers.

Aaron Dhiman 3 months ago Member's comment

yes, but the companies are not investing in the future. They are just buying back shares mostly to profit the Execs and Bankers.

Gary Anderson 3 months ago Contributor's comment

Well said Aaron. Mainstreet is getting auto loans but not much else from bankers these days.