The rise of zombie firms: A blessing or a curse to the economy?

In my view, zombie firms are not merely "zombies" for want of a better term. Their very existence is symptomatic of structural problems in the economy that have emerged over decades, as well as a failure of policymakers to address these issues head-on.

Rather than being a rare anomaly, zombie firms should be seen as the inevitable result of a system that has been increasingly rigged against economic efficiency and growth. For example, zombie firms enjoy a host of special privileges; they receive tax breaks and government bailouts while continuing to operate in ways that harm the rest of the economy and, ultimately, the taxpaying public. And because zombie firms often engage in behaviors that drive down productivity and innovation, it's hard to see how we can expect them to contribute meaningfully to future growth.

This is not to say that zombie firms are necessarily bad for society. Some, like IBM, even go on to thrive once government support ends. But too many zombie firms remain on life support far beyond the point where they could reasonably be expected to return to health on their own. It's not just that zombie firms drag down the overall performance of U.S. companies—they also have outsized influence over financial markets, especially when it comes to interest rates. Zombie firms play a direct role in driving up borrowing costs, which then pushes up consumer prices.

Factors affecting the prominent rise of Zombie firms

While the global financial crisis was certainly a contributing factor in the rise of zombie firms, there had long been a concern about the number and duration of these bankruptcies. I don't believe that the 2008 crisis caused the problem but rather that it exposed a deeper issue that needed to be addressed.

As a result, policymakers started to grapple with the question of what exactly is causing the vast numbers of zombies to emerge. While the precise causes vary by firm, research shows that the root cause of zombie firms lies in the business model itself and its impact on the broader economy. A few key factors explain why so many zombie firms have risen to prominence.

First, zombie firms tend to have a very short life span. By definition, they survive for fewer than five years before going bankrupt. Once they've expired, however, they're only rarely reborn. That means that most zombie companies must be replaced by new ones, either through mergers or acquisitions. These processes generate a constant churn within the corporate sector, which in turn drives up the demand for mergers and acquisitions bankers, lawyers, accountants, and others who help manage these deals.

Second, zombie firms are often much larger than average. Certain data show that zombie firms are typically twice as large as non-zombie firms, both in terms of nominal and real revenues. They also have higher levels of intangible assets, which makes them more vulnerable to swings in the value of those assets. Again, zombie firms are usually highly leveraged. On average, zombie firms carry almost three times the level of leverage as non-zombie companies do. All of these characteristics put zombie firms at greater risk and increase the likelihood that they will face bankruptcy.

Third, zombie firms are also less efficient than non-zombie businesses. In particular, zombie firms exhibit lower returns on assets and equity compared with their peers. The reason for this is simple: zombies tend to take on excessive amounts of debt and invest in activities that generate little or no economic benefit. Typically, zombie firms concentrate on high-risk endeavors such as speculative investment and mergers and acquisitions.

Fourth, zombie firms often do not have strong management teams. Even if zombie firms managed to survive long enough to file for bankruptcy, they were unlikely to hire senior executives who could steer them to success. Instead, they would recruit younger managers who lack experience leading large organizations. This type of mismanagement leads to poor decision-making and a lack of focus on innovation.

Finally, zombie firms are often too big to fail. Unlike other firms, zombie firms are too large to simply close down, and their demise would have a severe effect on the economy. For this reason, Congress created special mechanisms for rescuing failing banks and companies, which meant that zombie firms survived longer than they might have otherwise. However, once the financial crisis ended, regulators moved to dismantle these financial safety nets.

How policymakers can help with restructuring

The United States remains one of the most dynamic economies in the world, despite the challenges it faces today. They have a responsibility to ensure that the benefits of growth are broadly shared. To that end, I believe that policymakers need to tackle the problem of zombie firms head-on.

Policymakers could begin by reforming capital requirements to encourage more responsible lending practices. There is no single solution for zombie firms, but I think that an effective approach would involve dismantling some of the special protections that have allowed zombies to thrive.

This includes eliminating corporate welfare programs, such as tax breaks, and reducing the size and scope of the federal government. Ultimately, we hope that these efforts will allow zombie firms to die naturally. If not, they will eventually be forced to do so.

Making the Most of the Opportunity

Zombie firms can pose a real threat to the economy. Fortunately, there are strategies that policymakers can follow to help reduce the number of zombie firms in the future.

I believe that addressing the problem starts with changing the incentives that create zombie firms in the first place as mentioned above.

One way to achieve this goal would be to remove legal barriers that prevent the failure of large, inefficient firms. This is particularly important for zombie firms since they are more likely to be too big to fail.

Another step would be to overhaul corporate governance rules so that zombie firms are easier to manage.

Lastly, I suggest creating a regulatory framework that encourages healthy competition among zombie firms. Such a system would discourage zombie firms from taking advantage of loopholes to avoid paying taxes and instead promote stronger, more focused competition across industries. These steps would go a long way toward addressing the problem of zombie firms.

However, it's recognizable that policymakers may struggle to implement these changes in a timely manner. In this case, they will need to consider additional policy responses to keep zombie firms from threatening the overall health of the economy.

One possibility would be to introduce a temporary program aimed at helping zombie firms exit the market. This could include providing subsidies for zombie firms to sell off unwanted assets, offer buyouts to employees, and renegotiate contracts with lenders. It's also possible to give zombie firms access to loans at low-interest rates.

However, policymakers must remain mindful of the risks associated with such policies. If zombie firms are given an easy way out, they may grow larger than they would have been otherwise—and ultimately pose a greater risk to the economy.

A few research suggests that many zombie firms could be managed more efficiently. For example, zombie firms tend to invest in speculative ventures rather than profitable ones. A better strategy would be to focus on core competencies and pursue a narrow set of projects that deliver targeted returns.

Similarly, zombie firms could improve their operations by employing more skilled workers and spending more on R&D. There is nothing wrong with pursuing growth opportunities, but zombie firms should understand when the pursuit of aggressive growth has become unproductive. This is especially true for zombie firms that engage in risky investments, such as M&A deals.

Therefore, to address the problems caused by zombie firms, policymakers must consider several issues. First, they should look into ways to limit the impact of zombie firms on society. Second, they should investigate how to protect vulnerable groups against the negative impacts of zombie firms. Finally, they should explore whether zombie firms should be allowed to exist in the first place.

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