Summary
20 Percent of the Largest Public Firms Now Zombies
Resources:
https://accountinginsights.org/economic-impact-and-analysis-of-zombie-companies/
Here’s how it usually unfolds:
1. Continuous Capital Dependence
- The company survives by rolling over debt or issuing new equity because its core operations don’t produce sufficient cash.
- This works as long as credit markets remain liquid, and investor confidence persists.
2. Rising Cost of Capital
- As the company’s fundamentals remain weak, lenders and investors demand higher interest rates or deeper equity discounts.
- Dilution from repeated equity issuance erodes shareholder value, making future rises harder.
3. Trigger Event
- A macroeconomic shock (e.g., interest rate hikes, credit tightening, recession) or sector-specific downturn occurs.
- Access to cheap capital disappears. Banks pull credit lines, and bond markets close for high-risk issuers.
4. Liquidity Crunch
- Without new financing, the company cannot:
- Pay interest or principal on existing debt.
- Cover operating expenses.
- Vendors may demand cash up front, worsening liquidity.
5. Default and Insolvency
- Missed interest or principal payments trigger loan covenants and cross-default clauses.
- Creditors may accelerate debt repayment or push for bankruptcy.
6. Bankruptcy or Liquidation
- Chapter 11 (restructuring): Creditors convert debt to equity, wiping out existing shareholders.
- Chapter 7 (liquidation): Assets sold off, often at fire-sale prices. Equity holders get nothing.
Why It’s Often Sudden
Zombie companies can appear stable for years because they mask insolvency with external financing. The collapse seems abrupt because the moment capital markets shut, the company’s inability to self-sustain becomes obvious, highlighting the need for early detection and prevention.
Here are some historical examples of zombie company failures and near-failures that illustrate how the collapse typically unfolds:
1. Altice France (2023)
- Industry: Telecommunications
- Altice France’s collapse disrupted multiple European industries and created funding challenges for otherwise stable companies, demonstrating how interconnected zombie firms can trigger systemic risk. This interconnectedness is a key factor in understanding the broader economic implications of zombie company collapses.
2. Japanese Retailer Daiei (1990s)
- Industry: Retail
- What Happened: During Japan’s “Lost Decade,” Daiei expanded aggressively during the asset bubble but became a zombie firm after the crash. It survived for years through bank support and debt rollovers before eventually being restructured.
3. WeWork (2019–2023)
- Industry: Real Estate / Co-working
- What Happened: WeWork burned through billions in cash and relied on repeated equity infusions and debt issuance. When investor confidence collapsed after its failed IPO, it spiraled into restructuring and bankruptcy in 2023.
4. Hertz (2020)
- Industry: Car Rental
- What Happened: Hertz had been financially weak for years, rolling over debt and issuing equity. The COVID-19 travel collapse removed its last lifeline, forcing bankruptcy when it couldn’t refinance.
5. Toys “R” Us (2017)
- Industry: Retail
- What Happened: Saddled with massive LBO debt, Toys “R” Us operated as a zombie for years, paying interest but unable to invest in growth. When credit markets tightened and e-commerce competition intensified, it filed for bankruptcy.
6. Common Pattern
- All these companies depended on external financing rather than operational cash flow.
- A collapse occurred when credit markets tightened or investor confidence evaporated, cutting off the refinancing lifeline.
Zombie companies pose serious systemic economic risks because they distort resource allocation, weaken financial stability, and amplify vulnerabilities during economic shocks. Here’s a structured analysis:
7. Resource Misallocation and Productivity Drag
- Zombie firms tie up capital and labor that could otherwise flow to productive businesses, reducing overall economic efficiency.
- They stifle innovation because they allocate minimal resources to R&D or growth, focusing instead on survival. This leads to lower productivity growth across the economy.
8. Credit Market Distortions
-
Banks often roll over loans to avoid recognizing losses (a practice called “evergreening”), which distorts credit risk assessment.
- This creates a moral hazard: lenders expect bailouts or government support, leading to complacency in risk management.
- Over time, this weakens bank balance sheets, reducing their ability to fund healthy firms and amplifying systemic fragility.
9. Financial Stability Risks
- Zombie firms increase the correlation of risk in the financial system. If credit conditions tighten or interest rates rise, many zombies fail simultaneously, triggering:
- Loan defaults → bank losses.
- Bond market stress → higher spreads and liquidity crunch.
- This can lead to a credit crunch, where even healthy firms lose access to financing, deepening recessions.
10. Economic Growth Suppression
- Persistent zombification lowers aggregate investment because zombies crowd out capital for dynamic firms.
- Studies show that economies with high zombie prevalence experience slower GDP growth and weaker post-crisis recoveries (e.g., Japan’s “Lost Decade”).
11. Amplification During Crises
- During downturns, policy measures such as cheap credit and loan forbearance (e.g., COVID-19 stimulus) can unintentionally prop up unviable firms, thereby delaying necessary restructuring.
- This creates a ratchet effect: zombie shares rise after each crisis and rarely return to pre-crisis levels, leading to long-term economic stagnation and underscoring the urgency of addressing this issue.
12. Systemic Risk Summary
Zombie companies act as “silent contagion carriers” in the economy:
- They mask insolvency risk during good times.
- When liquidity dries up, they collapse en masse, stressing banks, bond markets, and employment.