Zombie Company

A zombie company is a firm that for years has made too little profit to service its own debts. Anyone who borrows money must pay interest on it regularly, that is, a fee to the lender. It is precisely this interest that such a company can no longer raise from its ongoing business. In theory, it should therefore close down or be sold. But it survives because banks roll over old loans or the state pays subsidies. The name alludes to the undead of the movies: not truly alive anymore, but not dead either.

Why economists speak of capital that is stuck

Every economy has only a limited amount of money, labor, and machinery. When these resources are tied up in companies that permanently generate no return, they are missing elsewhere. A young company with a good idea then finds it harder to get a loan or cannot find skilled workers. Economists call this a misallocation, that is, a wrong distribution of scarce resources.

Studies by the Bank for International Settlements show a clear increase. In the 1980s, around two percent of listed companies in industrialized countries were considered zombies. Most recently, estimates ranged from ten percent and above, depending on the definition. The phenomenon was especially pronounced in Japan after the real estate crisis of the 1990s.

The effect also hits healthy competitors. A zombie lowers prices just to generate any revenue at all, because it only wants to survive anyway. This drags down the profits of the entire industry. Experts speak of a drag on productivity, that is, on the question of how much an economy produces per hour worked.

How to recognize a zombie

The most common definition works with two conditions. First, a company’s operating profit must be smaller than its due interest payments for at least three consecutive years. Second, the firm must be at least ten years old. The second condition excludes start-ups that initially make losses as planned and later become profitable.

The decisive metric is the interest coverage ratio. It relates profit before interest and taxes to interest expenses. If the value is permanently below one, the business is not sufficient to cover the interest. The gap is then plugged with new loans, which further increases the debt.

Why do banks go along with this? If a bank writes off a loan as lost, it must immediately record the loss on its balance sheet. If it extends the loan instead, the balance sheet looks better in the short term. Experts call this behavior evergreening, that is, the artificial keeping-alive of bad loans. Low interest rates additionally reinforce the effect, because the ongoing cost of the debt is then very small.

Interest rate turnaround, Covid aid, and insolvency statistics

In economic news, the term usually comes up when central banks change interest rates. For ten years, key interest rates in Europe stayed near zero, after which they rose sharply from 2022 onward. For companies with high debt, interest costs thus multiplied. This is precisely why reports of rising insolvency figures in Germany have accumulated since then.

A second occasion was the state Covid aid and the temporarily suspended obligation to file for insolvency. Critics warned at the time that the state was artificially keeping alive companies that were already unviable beforehand. Defenders countered that otherwise even healthy businesses would have gone under because of a brief exceptional situation. Both sides used the word zombie company as an argument.

An important distinction: a company with high debt is not yet a zombie. Many corporations deliberately finance factories through loans and make good money doing so. A single bad year is not enough either. Only the combination of permanent weakness, advanced age, and outside support makes the term fitting. Anyone who reads it in headlines should therefore check which definition the author is actually using.