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Global zombie companies: measurements, determinants, and outcomes
Abstract
Academics and practitioners are increasingly concerned about global zombieism, a term used to describe insolvent firms that survive with the support of financial institutions, investors, or governments, particularly during unusual market conditions. Using dual-filters of interest coverage ratio and an empirically validated default prediction model, we propose a new measure to gauge the extent of zombieism in the world’s 20 largest economies. The average zombie share of listed firms has increased significantly since 1990, to about 7% in 2020. Zombie firms are typically found among small and medium-sized enterprises. Economic growth, industry compositions, and lenient monetary policies have strong explanatory power for global zombieism. We show that the presence of zombie firms generates significant market congestion, limiting the growth of healthy firms. We also find that the development of global corporate bond markets contributes to zombie firm growth. Leveraging staggered bankruptcy reforms as an exogenous variation, we find that these reforms lower zombie ratio by 1.4% points. The reduction is more substantial if the bankruptcy law becomes more creditor-friendly. Having failed to recover, zombie firms can survive for an average of 5 years before declaring bankruptcy, being delisted, or being acquired. Bankruptcy reforms accelerate the dissolution of zombie status.
... Initial studies focused on Japan (Ahearne and Shinada, 2005;Caballero et al., 2008;Hoshi, 2006), later expanding to China and its influential environment Shen et al., 2023). The issue is now recognized globally, with zombie firms among listed companies rising to around 7% by 2020 (Altman et al., 2024). Altman et al. (2024) highlight its uneven spread across the world's 20 largest economies, prompting questions about the country-level factors driving this phenomenon. ...
... The issue is now recognized globally, with zombie firms among listed companies rising to around 7% by 2020 (Altman et al., 2024). Altman et al. (2024) highlight its uneven spread across the world's 20 largest economies, prompting questions about the country-level factors driving this phenomenon. A global analysis can reveal the structural economic, political and monetary conditions that influence the emergence and persistence of zombie companies. ...
... Another example is the 2008 crisis, in which several sectors were deemed "too big to fall" and heavily subsidized despite their practical bankruptcy to save the jobs. In this context, it is worth noting that most policymakers opted to maintain employment through highly subsidized interest rates and government stimuli (Altman et al., 2024). Zombies going out of business could create a wave of unemployment that might destabilize the economy. ...
Purpose
Research on the number of zombie companies and their economic impact has increased exponentially in recent years. However, their social impact is hardly analysed. Zombification is not a problem limited to only some countries, nor is it due only to company management; it is influenced by country-level institutional contexts. Using a utilitarian perspective, this paper aims to identify the country-level institutional contexts in which zombie companies arise and to analyse their social impact worldwide, taking inequality as a social indicator. Understanding zombification is vital for maximizing societal well-being.
Design/methodology/approach
The sample studied here consists of 87,573 companies from 115 countries with negative equity over the three business years from 2019 to 2021. A mediating model is proposed, in which the degree of zombification of a country mediates the relationship between the institutional context and income inequality. The utilitarian perspective is used as an effective practical approach that prioritizes maximizing overall societal well-being and outcomes.
Findings
The results indicate that the number of zombies is influenced by country-level economic and political aspects; however, zombies do not increase inequality in countries. Indeed, the opposite occurs: Zombie companies lead to a reduction in inequality (Gini Index), probably due to a poverty alleviation shock. From a utilitarian perspective, this outcome aligns with the goal of improving societal well-being.
Practical implications
This paper makes three contributions: firstly, the zombie problem is considered worldwide; secondly, country-level institutional factors are analysed to explain the existence of zombie companies; and thirdly, the social aspect is included as a relevant approach for understanding zombie theory.
Social implications
From a utilitarian perspective, the existence of zombie companies maximizes societal well-being by redistributing wealth from capital income to labour income. Despite the financial inefficiencies of zombie companies, they play a role in reducing income inequality and preventing poverty. This paper highlights the importance of considering social factors when assessing the broader impacts of zombie companies, as they contribute to poverty reduction and promote greater income equality in specific contexts.
Originality/value
A favourable institutional environment is not conducive to the elimination of zombie companies, but rather favours them. This paper concludes that zombie companies, contrary to their reputation as economic drains, contribute to reducing income inequality, measured by the Gini Index. This paper distinguishes itself by integrating social considerations into the economic analysis, providing a deeper understanding of the broader impacts of zombie companies.
... Zombie firms are insolvent but continue to operate due to unusual market conditions and support from financial institutions and governments (Altman et al. 2024, as cited in this study). The COVID-19 pandemic has led many governments and central banks to implement extensive corporate support programs to help businesses survive the economic shock without terminating many workers. ...
... In our study, to alleviate the concern of misidentifying zombies rather than low-quality firms, we define zombie firms as those unable to generate sufficient earnings or cash flows to meet their interest payments for at least a conservative period of three years but still able to survive. We also adopt the Altman et al. (2024) definition, using a two-step filtering process to determine zombie firms with an accounting-based measure and a default predictor. Additionally, we expand their research by examining not only periods of distress but also normal times. ...
... Secondly, using a large sample of firms from developed and developing countries, we provide new evidence on the prevalence of the zombie firms phenomenon throughout the world. We extended recent research that focused on more advanced economies (Banerjee and Hofmann 2018;Adalet McGowan et al. 2018;Altman et al. 2024;Acharya et al. 2024). ...
By examining a broad range of companies from both developed and developing nations from 2015 to 2021, we gather evidence on the occurrence and factors contributing to the existence of zombie firms. Approximately 10% of our observations are identified as zombie firms, and there is significant variability in the proportion of zombie firms across different countries. We find that countries with more efficient corporate insolvency rules tend to have a lower incidence of zombie firms. We also establish that a nation’s culture plays a vital role in determining the prevalence of zombie firms. More specifically, our findings indicate that countries with higher levels of individualism culture tend to have lower numbers of zombie firms.
... Moreover, extant literature has arrived at the "general conclusion [...] that larger firms are more likely to survive" as compared to SMEs (Rico et al., 2021, p. 118) or to become "zombie" firms (Altman et al., 2024). A primary concern for SMEs is their inherent lack of scale, which can significantly hinder their adaptability, sustainability and innovation capabilities in challenging times (Cultrera, 2020;Eggers, 2020). ...
This qualitative literature review examines the key predictors of SME recovery from severe financial distress, focusing on financial blockages, employee dynamics, and turnaround success. The study synthesizes findings from various sources to highlight how financial challenges such as liquidity shortages and limited access to credit hinder recovery, while government support and alternative financing offer potential solutions. Additionally, employee engagement, organizational culture, and strategic leadership are identified as critical factors in successful turnaround efforts. SMEs that foster innovation, adaptability, and retain key employees are more likely to overcome financial crises. The review emphasizes the importance of a holistic approach, combining financial relief, strategic leadership, and organizational resilience, for long-term SME recovery. The findings suggest avenues for future research on the interaction of these factors and their context-specific impacts.
Rozważania przedstawione w artykule mają na celu ustalenie, czy specyfika przedsiębiorstw rodzinnych wpływa na odmienną ocenę ryzyka niekontynuowania przez nie działalności. Przy ciągłych zmianach i niepewnych warunkach, jakie są obserwowane na przestrzeni ostatnich lat, pogłębienie wiedzy dotyczącej tej tematyki może okazać się bardzo przydatne, tym bardziej jeśli weźmie się pod uwagę dominujący udział spółek rodzinnych w gospodarce. Badanie przeprowadzono w kontekście teoretycznych i praktycznych podstaw odrębności przedsiębiorstw rodzinnych. Na podstawie danych z bazy Orbis dotyczących lat 2013–2020 dla 785 057 przedsiębiorstw oszacowano modele logitowe. Wskazano na różnice w czynnikach wpływających na prawdopodobieństwo niekontynuowania działalności przez przedsiębiorstwa rodzinne i przez przedsiębiorstwa nierodzinne. W przypadku spółek rodzinnych potrzebne jest odrębne podejście do predykcji niekontynuowania działalności. Wskaźnik zdolności obsługi długu z kapitału pracującego wykazywał w predykcji likwidacji spółek rodzinnych tendencje przeciwne niż w odniesieniu do łącznej populacji (bez rozróżnienia między podmiotami rodzinnymi a komercyjnymi) oraz próby przedsiębiorstw komercyjnych badanych osobno od rodzinnych.
Digital transformation stimulates enterprise development but its effects on zombification are uncertain. This study analyzed the effects of digital transformation on de‐zombification among A‐share listed Chinese companies in Shanghai and Shenzhen Stock Exchanges from 2009 to 2021 and the mechanisms underlying those effects. The findings indicated that digital transformation facilitated enterprise de‐zombification, with a stronger effect observed in state‐owned enterprises, high‐tech enterprises, firms in industries with low levels of competition, those with advanced digital transformation, and cities with high levels of government intervention. Further analysis identified improved production efficiency and capital allocation as important factors enabling this process. Enterprises at risk of zombification should prioritize digital transformation as a fundamental strategy for recovery. Governance strategies should be tailored to the specific characteristics of various types of zombie enterprises. The government may consider offering financial or tax incentives to assist these firms in their digital transformation efforts, enabling them to overcome the challenges associated with zombification while enhancing both production efficiency and the efficacy of capital allocation.
Zombie firms have gained considerable attention due to their increasing global presence, particularly in emerging economies like India. Despite efforts to understand the effects of rising zombie firms on various aspects of the economy, there is still a need for a comprehensive study regarding their specific impact on healthy and viable firms. This study fills this gap by examining how the increasing share of zombie firms affects healthy firms’ industrial upgradation by impacting productivity, trade and innovation efforts. By utilising a standard panel data estimation strategy, the study examined the impact of zombie firms’ overall industrial efficiency in terms of zombie presence in export, import, and R&D within an industry. Using a sample of 10,090 Indian manufacturing firms, this paper demonstrates that an industry’s overall productivity declines with the increase in zombies’ participation in cross-border trade (i.e. imports and exports) and R&D activities. The findings of the study give insights into the congestion effect of zombie firms on healthy firms and have implications for international trade and robust policy intervention.
The objective of the study was to develop a method to detect zombie firms in a sample of mainly very small companies. The original sample consisted of 70,809 active and 134 bankrupt Finnish companies (or firms in insolvency proceedings) for 2018–2020. In the sample firms, the median number of employees was only 2. First, a logistic regression model to measure bankruptcy risk was estimated using three financial ratios as independent variables reflecting profitability, liquidity and solvency. Zombie firms were defined as active companies which are technically bankrupt but are still operating in the market. Second, following this definition, the model was used to assess the bankruptcy risk of active firms, and a zombie company was operationally defined as an active company whose bankruptcy risk exceeds the median for bankrupt companies in three consecutive years. In this way, over 2000 zombie companies were detected making in total 3.5% of the active companies.
The resources sunk in zombie firms have risen over the last two decades, hampering productivity growth in developed economies. In this paper, we examine the recovery and exit of zombie firms among small- and medium-sized enterprises (SME), as well as the determinants of these transitions. To our knowledge, this is the first study on the determinants of the probability of a zombie recovering or exiting in a European context. The study also contributes to the discussion of the definition of zombie firms. Based on a panel of Portuguese manufacturing and services firms covering the 2004–2017 period, we do find a widespread presence of zombies. As expected, they are relatively less productive than non-zombies, while the probability of transition into recovery and exit is relatively low, which we interpret as evidence in favour of the presence of high barriers to firm mobility. In turn, the regression results show that downsizing and restructuring, as well as debt restructuring, are crucial in enhancing recovery of zombie firms. These are non-trivial results from the perspective of managers and policy makers. We performed several exercises using alternative definitions of zombie firms and estimation techniques and found that our findings are robust.
Plain English Summary A 1% decline in the share of highly indebted and unprofitable firms (i.e. zombies) is estimated to increase the average labour productivity by 3.1 percent. Recovery of zombies in particular can be enhanced by downsizing and restructuring. Based on a very large panel of Portuguese small- and medium-sized manufacturing and services firms, covering the 2004–2017 period, we do find a widespread presence of zombie firms. Moreover, the chance of these firms to recover or exit is relatively low, an evidence of the presence of high barriers to firm mobility and resource misallocation. Our results have important managerial and policy implications: (1) a coordinated and holistic restructuring strategy (technological, operational and debt-related) is crucial to increase the likelihood of recovery of weak companies; (2) governments should formulate an adequate institutional framework in order to strengthen the selection of zombie firms, namely by designing more reallocation-friendly insolvency regimes and discouraging creditors to refinance unviable firms.
Launched in Summer 2012, the European Central Bank’s (ECB) Outright Monetary Transactions (OMT) program indirectly recapitalized European banks through its positive impact on periphery sovereign bonds. However, the stability reestablished in the banking sector did not fully translate into economic growth. We document zombie lending by banks that remained weakly capitalized even post-OMT. In turn, firms receiving loans used these funds not to undertake real economic activity, such as employment and investment, but to build cash reserves. Creditworthy firms in industries with a high zombie firm prevalence significantly suffered from this credit misallocation, which further slowed the economic recovery.
Received March 21, 2018; editorial decision November 13, 2018 by Editor Philip Strahan. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.
In many countries, poorly functioning bankruptcy procedures force viable but insolvent firms to restructure out of court, where banks may have a bargaining advantage over other creditors. We model the choice of restructuring process and derive implications for the corporate mix of bank and bond financing. Empirical patterns match the model: inefficient bankruptcy in a country is associated with less bond issuance by risky, but not by safe, borrowers. This pattern holds for both levels of and changes in bankruptcy recovery. Our results establish a link between bankruptcy reform and corporate bond markets, especially high-yield markets.
Received September 29, 2014; accepted February 1, 2016 by Editor David Denis.
This paper assesses the classification performance of the Z-Score model in predicting bankruptcy and other types of firm distress, with the goal of examining the model's usefulness for all parties, especially banks that operate internationally and need to assess the failure risk of firms. We analyze the performance of the Z-Score model for firms from 31 European and three non-European countries using different modifications of the original model. This study is the first to offer such a comprehensive international analysis. Except for the United States and China, the firms in the sample are primarily private, and include non-financial companies across all industrial sectors. We use the original Z''-Score model developed by Altman, Corporate Financial Distress: A Complete Guide to Predicting, Avoiding, and Dealing with Bankruptcy (1983) for private and public manufacturing and non-manufacturing firms. While there is some evidence that Z-Score models of bankruptcy prediction have been outperformed by competing market-based or hazard models, in other studies, Z-Score models perform very well. Without a comprehensive international comparison, however, the results of competing models are difficult to generalize. This study offers evidence that the general Z-Score model works reasonably well for most countries (the prediction accuracy is approximately 0.75) and classification accuracy can be improved further (above 0.90) by using country-specific estimation that incorporates additional variables.
We argue that when bankruptcy code is creditor friendly, excessive liquidations cause levered firms to shun innovation, whereas
by promoting continuation upon failure, a debtor-friendly code induces greater innovation. We provide empirical support for
this claim by employing patents as a proxy for innovation. Using time-series changes within a country and cross-country variation
in creditor rights, we confirm that a creditor-friendly code leads to a lower absolute level of innovation by firms, as well
as relatively lower innovation by firms in technologically innovative industries. When creditor rights are stronger, technologically
innovative industries employ relatively less leverage and grow disproportionately slower.
We examine the misallocation of credit in Japan associated with the perverse incentives faced by banks to provide additional credit to the weakest firms. Firms are more likely to receive additional bank credit if they are in poor financial condition, because troubled Japanese banks have an incentive to allocate credit to severely impaired borrowers in order to avoid the realization of losses on their own balance sheets. This "evergreening" behavior is more prevalent among banks that have reported capital ratios close to the required minimum, and is compounded by the incentives arising from extensive corporate affiliations.
We show that “zombie credit”—subsidized credit to nonviable firms—has a disinflationary effect. By keeping these firms afloat, zombie credit creates excess aggregate supply, thereby putting downward pressure on prices. Granular European data on inflation, firms, and banks confirm this mechanism. Markets affected by a rise in zombie credit experience lower firm entry and exit, capacity utilization, markups, and inflation, as well as a misallocation of capital and labor, which results in lower productivity, investment, and value added. If weakly capitalized banks were recapitalized in 2009, inflation in Europe would have been up to 0.21 percentage points higher post‐2012.
We conjecture that angel investment in entrepreneurial firms depends on two types of bankruptcy laws around the world. Corporate bankruptcy laws impact investor terms and incentives to finance risky entrepreneurs, particularly given reforms that brought about a time-efficient, simplified, and clear process in recent years in some countries. Personal bankruptcy laws impact entrepreneurial motivations to engage in risk-taking and entrepreneurship and thus affect the demand for angel financing. In this paper, we examine 35,752 angel investments from 72 countries from 2000 to 2020 and compare the relative importance of corporate and personal bankruptcy laws for angel investment activities. The data indicate that corporate bankruptcy law reforms and personal bankruptcy law reforms both positively influence angel investment activities. The data further suggest that countries that reformed both laws had the most pronounced improvements in angel activities. These findings are robust using a quasi-experimental approach of the difference-in-differences method, clustering standard errors, and excluding U.S. observations, among other strategies.
The unprecedented fiscal and monetary policy support in the wake of the COVID-19 pandemic has brought to the fore concerns that cheap credit could fuel the financing of zombie firms—that is, firms that are unable to generate enough profits to cover debt-servicing costs and that need to borrow to stay alive. Many observers have recently commented that zombie firms may crowd out lending to productive firms and erode the strength of the U.S. economy.
This article surveys the theory on zombie lending incentives and the consequences of zombie lending for the real economy. It also offers a historical perspective by reviewing the growing empirical evidence on zombie lending along three dimensions: ( a) the role of undercapitalized banks, ( b) effects on zombie firms, and ( c) spillovers and distortions for non-zombie firms. We then provide an overview of how zombie lending can be attenuated. Finally, we use a sample of US publicly listed firms to compare various measures proposed in the literature to classify firms as “zombies.” We identify definitions of zombie firms that are adequate to investigate economic inefficiency in the form of real sector competitive distortions of zombie lending. We find that only definitions based on interest rate subsidies are able to detect these spillovers and thereby provide evidence in support of credit misallocation.
Expected final online publication date for the Annual Review of Financial Economics, Volume 13 is November 2022. Please see http://www.annualreviews.org/page/journal/pubdates for revised estimates.
“Zombie lending” remains a widespread practice by banks around the world. In this paper, we exploit a series of large-scale on-site inspections made on the credit portfolios of several Portuguese banks to investigate how these inspections affect banks’ future lending decisions. We find that an inspected bank becomes 20% less likely to refinance zombie firms, immediately spurring their default. Overall, banks seemingly reduce zombie lending because the incentives to hold these loans disappear once they are forced to recognize losses.
This paper was accepted by Tomasz Piskorski, finance.
“Zombie lending”--lending to less-productive firms at subsidized rates--can help banks with misaligned incentives in the short run, but it prolongs economic downturns. We propose that inefficient resolution of insolvency is a significant contributor to this problem. We exploit variation in the efficiency of insolvency across countries to show that lack of formal bankruptcies, cheap (zombie) credit, and stickiness of existing creditors is more common in bad economic periods when insolvency works less well.
Using firm-level data on listed non-financial companies in 14 advanced economies, we document a rise in the share of zombie firms, defined as unprofitable firms with low stock market valuation, from 4% in the late 1980s to 15% in 2017. These zombie firms are smaller, less productive, more leveraged, invest less in physical and intangible capital and shrink their assets, debt and employment. Their performance deteriorates several years before zombification and remains significantly poorer than that of non-zombie firms in subsequent years. Over time, some 25% of zombie companies exited the market, while 60% exited from zombie status. However, recovered zombies underperform compared to firms that have never been zombies and they face a high probability of relapsing into zombie status.
Debt overhang is associated with higher financial fragility and slower recovery from recession. However, while household credit booms have been extensively documented to have this property, we find that corporate debt does not fit the same pattern. Newly collected data on nonfinancial business liabilities for 18 advanced economies over the past 150 years shows that, in the aggregate, greater frictions in corporate debt resolution make for slower recoveries, with weak investment and more persistent “zombie firms” and that this is an important factor in explaining the difference in outcomes relative to household credit booms.
Using data on bank-firm relationships in Italy during the Eurozone financial crisis, we show that: (i) compared to healthy banks, under-capitalized banks cut credit to healthy but not to zombie firms and are more likely to prolong a credit relationship with a zombie; (ii) in areas-sectors with more low-capital banks, zombies are more likely to survive; (iii) nevertheless, bank under-capitalization does not hurt the growth rate of healthy firms. We provide evidence that extending credit to the weakest firms during the recession mitigated the disruption of supply chains and adverse local demand externalities.
We study the effects of country-level creditor protections on the firm-level choice of debt structure concentration. Using data from 46 countries, we show that firms form more concentrated debt structures in countries with stronger creditor protection. We propose a trade-off framework of optimal debt structure and show that in strong creditor rights regimes, the benefit of forming concentrated structures outweighs its cost. Because strong creditor protections increase liquidation bias, firms choose concentrated debt structures to improve the probability of successful distressed debt renegotiations. Firms with ex-ante higher bankruptcy costs, including those with higher intangibility, cash flow volatility, R&D expenses, and leverage exhibit stronger effects. Firms with restricted access to capital are also affected more. A difference-in-differences analysis of firms’ debt structure responses to creditor rights reforms confirms the cross-country results. Our findings are robust to alternative settings and a battery of robustness checks.
Using a comprehensive dataset of firms from seventy-nine countries, we document the incidence, determinants, and corporate policies of zombie firms for the 2005–2016 period. Zombie firms account for roughly 10% of our observations. We find that countries with more efficient debt enforcement environments tend to have fewer zombie firms. We find no evidence that the prevalence of zombie firms is related to national culture. We further find that zombie firms have conservative dividend and investment policies, aggressive leverage policies, and higher idiosyncratic risk. We conclude that zombie firms may impose a cost on the economy by impeding efficient resource allocation.
This paper explores the extent to which ‘zombie’ firms – defined as old firms that have persistent problems meeting their interest payments – are stifling labour productivity performance. The results show that the prevalence of and resources sunk in zombie firms have risen since the mid-2000s and that the increasing survival of these low productivity firms at the margins of exit congests markets and constrains the growth of more productive firms. Controlling for cyclical effects, cross-country analysis shows that within-industries over the period 2003–13, a higher share of industry capital sunk in zombie firms is associated with lower investment and employment growth of the typical non-zombie firm and less productivity-enhancing capital reallocation. Besides limiting the expansion possibilities of healthy incumbent firms, market congestion generated by zombie firms can also create barriers to entry and constrain the post-entry growth of young firms. Finally, we link the rise of zombie firms to the decline in OECD potential output growth through two key channels: business investment and multi-factor productivity growth.
An extensive body of international business research examines how cross-country variations in legal institutions influence corporate finance practices. Building on this literature, as well as the literature on capital structure and product market interactions, we investigate the effect of an important dimension of legal institutions – creditor rights – on the product market performance of highly leveraged firms. Using a sample of 37,422 firms from 60 countries over the 1989–2016 period, we find that strong creditor protection benefits less leveraged firms, but adversely affects highly leveraged firms by increasing the adverse responses of customers, competitors, and employees. The adverse effect of creditor rights on the costs of high leverage is more pronounced for firms in countries with developed debt markets and banking systems, but mostly insignificant for firms in countries with developed equity markets and low information asymmetry. Our study offers new insights into the international business literature and contributes to the debate on the role of creditor protection by uncovering a potential cost based on capital structure and product market interactions.
Loan tranching allows banks to manage risk and facilitate firm financing, which may be essential for firms that cannot access investors from stock markets. We analyze the determinants and benefits of loan tranching by pooling the tranches of individual loans to create the largest cross-country sample of syndicated loans, covering more than 150,000 loans from multinational and domestic firms. We find that, in addition to market, deal, and borrower characteristics, legal and institutional differences impact loan tranching. Strong creditor protection and efficient debt collection increase the probability of tranching and reduce tranche spreads, ultimately promoting firms’ access to debt. We also find evidence that tranching facilitates the financing of multinational firms abroad due to the transfer of legal and cultural institutions to foreign subsidiaries. Overall, our results suggest that tranching plays an important role in reducing a country’s financial development gap and promotes firms’ access to debt.
Pursuing delinquent borrowers requires considerable effort, and creditors may lack the incentive to exert this costly effort in uncompetitive banking sectors. To examine this, we use a uniquely large data set of public and private corporate bankruptcy filings spanning a banking-sector reform that deregulated bank entry across different regions of India. We find that increased banking competition is associated with more firms seeking a stay on assets, a decline in bankruptcy duration, and a shift toward workouts rather than liquidations. The results are consistent with creditors exerting greater effort to pursue delinquent firms and resolve bankruptcies more quickly when competition increases.
We argue that the prospect of an imperfect enforcement of debt contracts in default reduces shareholder-debtholder conflicts and induces leveraged firms to invest more and take on less risk as they approach financial distress. To test these predictions, we use a large panel of firms in 41 countries with heterogeneous debt enforcement characteristics. Consistent with our model, we find that the relation between debt enforcement and firms’ investment and risk depends on the firm-specific probability of default. A differences-in-differences analysis of firms’ investment and risk taking in response to bankruptcy reforms that make debt more renegotiable confirms the cross-country evidence.
We exploit variation in the congestion of civil courts across Brazilian municipalities, together with a bankruptcy reform increasing secured creditors’ protection, to estimate the effect of enforcement on firm access to finance, investment, and size. We find that firms operating in municipalities with less congested courts experienced a larger increase in the use of secured loans, as well as a larger increase in investment and value of output in the years after the reform. To establish the direction of causality, we use an instrumental variable strategy that exploits Brazilian state laws on judicial organization, and focus on differences in court congestion across otherwise similar neighboring municipalities located across judicial district borders within the same state. The evidence indicates that differences in court enforcement affect the impact of financial reform on firm access to finance, investment, and size. JEL Codes: G33, O16.
Exploiting the timing of the 2005–2006 Italian bankruptcy law reforms, we disentangle the effects of reorganization and liquidation in bankruptcy on bank financing and firm investment. A 2005 reform introduces reorganization procedures facilitating loan renegotiation. The 2006 reform subsequently strengthens creditor rights in liquidation. The first reform increases interest rates and reduces investment. The second reform reduces interest rates and spurs investment. Our results highlight the importance of identifying the distinct effects of liquidation and reorganization, as these procedures differently address the tension in bankruptcy law between the continuation of viable businesses and the preservation of repayment incentives.
Because of limited liability, insolvent banks have an incentive to continue lending to insolvent borrowers, in order to hide
losses and gamble for resurrection, even though this is socially inefficient. We suggest a scheme that regulators could use
to solve this problem. The scheme would induce banks to reveal their bad loans, which can then be dealt with. Bank participation
in the scheme would be voluntary. Even though banks have private information on the quantity of bad loans on their balance
sheets, the scheme avoids creating windfall gains for bank equity holders. In addition, some losses can be imposed on debt
holders.
We propose that stronger creditor rights in bankruptcy affect corporate investment choice by reducing corporate risk-taking. In cross-country analysis, we find that stronger creditor rights induce greater propensity of firms to engage in diversifying acquisitions that are value-reducing, to acquire targets whose assets have high recovery value in default, and to lower cash-flow risk. Also, corporate leverage declines when creditor rights are stronger. These relations are usually strongest in countries where management is dismissed in reorganization and are also observed over time following changes in creditor rights. Our results thus identify a potentially adverse consequence of strong creditor rights.
Models of financial distress rely primarily on accounting-based information (e.g. [Altman, E., 1968. Financial ratios, discriminant analysis and the prediction of corporate bankruptcy. Journal of Finance 23, 589–609; Ohlson, J., 1980. Financial ratios and the probabilistic prediction of bankruptcy. Journal of Accounting Research 19, 109–131]) or market-based information (e.g. [Merton, R.C., 1974. On the pricing of corporate debt: The risk structure of interest rates. Journal of Finance 29, 449–470]). In this paper, we provide evidence on the relative performance of these two classes of models. Using a sample of 2860 quarterly CDS spreads we find that a model of distress using accounting metrics performs comparably to market-based structural models of default. Moreover, a model using both sources of information performs better than either of the two models. Overall, our results suggest that both sources of information (accounting- and market-based) are complementary in pricing distress.
This paper investigates the role of vulture investors in the governance and reorganization of a sample of 288 firms that default on their public debt. The improvement in post-restructuring operating performance relative to the pre-default level is greater when the vulture investor becomes CEO or chairman or gains control of the target firm. We also find positive abnormal returns for the target's common stock and bonds in the two days surrounding the announcement of a vulture purchase of public debt or equity. Our evidence suggests that vulture investors add value by disciplining managers of distressed firms.
Assistant Professor of Finance, New York University. The author acknowledges the helpful suggestions and comments of Keith V. Smith, Edward F. Renshaw, Lawrence S. Ritter and the Journal' reviewer. The research was conducted while under a Regents Fellowship at the University of California, Los Angeles.
Large Japanese banks often engaged in sham loan restructurings that kept credit flowing to otherwise insolvent borrowers (which we call zombies). We examine the implications of suppressing the normal competitive process whereby the zombies would shed workers and lose market share. The congestion created by the zombies reduces the profits for healthy firms, which discourages their entry and investment. We confirm that zombie-dominated industries exhibit more depressed job creation and destruction, and lower productivity. We present firm-level regressions showing that the increase in zombies depressed the investment and employment growth of non-zombies and widened the productivity gap between zombies and non-zombies. (JEL G21, G32, L25)
Using a sample of small firms that defaulted on their bank debt in France, Germany, and the United Kingdom, we find that large differences in creditors' rights across countries lead banks to adjust their lending and reorganization practices to mitigate costly aspects of bankruptcy law. In particular, French banks respond to a creditor-unfriendly code by requiring more collateral than lenders elsewhere, and by relying on collateral forms that minimize the statutory dilution of their claims in bankruptcy. Despite such adjustments, bank recovery rates in default remain sharply different across the three countries, reflecting very different levels of creditor protection. Copyright 2008 by The American Finance Association.
Zombie firms are those firms that are insolvent and have little hope of recovery but avoid failure thanks to support from their banks. This paper identifies zombie firms in Japan, and compares the characteristics of zombies to other firms. Zombie firms are found to be less profitable, more indebted, more dependent on their main banks, more likely to be found in non-manufacturing industries and more often located outside large metropolitan areas. Overall, larger size makes the firm less likely to be a zombie, but among small firms, relatively larger firms are more likely to be protected and become zombies. Controlling for profitability, the exit probability for zombie firms does not differ from that for non-zombies. Zombie firms tend to increase employment by more (but do not reduce employment by more) than non-zombies. Finally, when the proportion of zombie firms in an industry increases, job creation declines and job destruction increases, and the effects are stronger for non-zombies.
Insolvency regimes, zombie firms and capital reallocation
- Adalet Mcgowan
- M Andrews
- D Millot
Covid-19 and the credit cycle: 2020 revisited and 2021 outlook
- E I Altman
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Zombie credit and (dis)-inflation: Evidence from Europe. Working paper
- V T Acharya
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A scoring system for emerging market corporate bonds. Salomon Brothers
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