The Rise Of Zombie Firms: Causes And Consequences
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US companies with debt servicing costs exceeding profits have risen since the 2008 financial crisis, driven by Fed support & low interest rates.
Here is the full text of the note: “One consequence of aggressive Fed support to credit markets and long periods of low interest rates is that it interferes with the process of creative destruction and keeps companies alive that would otherwise have gone out of business. Since the 2008 financial crisis, leverage in the corporate sector has increased significantly, andthe share of companies in the United States which have debt servicing costs that are higher than profits has continued to increase, see chart below. This trend with a rising share of firms with an interest coverage ratio less than one is likely to continue going forward given the Fed’s commitment to keeping rates low and the ongoing support from the Fed to credit markets, see also here. This is a macroeconomic problem because zombie firms are less productive, and their existence lowers investment in and employment at more productive firms. In short, one side effect of central banks keeping rates low for a long time is that it keeps more unproductive firms alive, which ultimately lowers the long-run growth rate of the economy.”
Torsten Slok, “US: Rising Share Of Companies With Debt Servicing Costs That Are Higher Than Profits,” Deutsche Bank, June 14, 2020
Ryan Banerjee and Boris Hofmann, “The Rise Of Zombie Firms: Causes And Consequences,” Bank Of International Settelments, September 2018, https://www.bis.org/publ/qtrpdf/r_qt1809g.pdf
Ed Comment:Add to database. Can you get the full report? I’d like to see what he describes as “profit.” Presumably he means operating profit or EBIT, not EBITDA, PBT or PAT. No matter the measure, it seems hard to believe. Presumably it’s power low distributed with many tiny/zombie firms. “This is a macroeconomic problem because zombie firms are less productive, and their existence lowers investment in and employment at more productive firms. In short, one side effect of central banks keeping rates low for a long time is that it keeps more unproductive firms alive, which ultimately lowers the long-run growth rate of the economy.” This would only be true if 1) capital was constrained or 2) the talent used by these firms could be deployed more productively elsewhere. He assumes the first but is mistaken and probably hasn’t thought about the second. My guess is talent moves away from these firms.
Steve Comment:Yes this looks like individual firms, not weighed by market cap. Its’ a very short note, Cathy pulled it for us. Note the definition he uses is firms are older than 10 years, and an interest coverage ratio of < 1 for three years in a row. Perhaps this is in large part driven by fracking and associated firms? Aside Emmanuel Farhi died over the weekend (non-covid) Note BIS has done some research (2018) on Zombie’s across advanced economies, as of 2016 BIS broader measure ~ lines up with Slok’ US number (See Graph 2): “…Here we apply two alternative zombie classifications to listed non-financial corporates in 14 advanced economies using the Worldscope database covering 32,000 companies. The first, broader measure…identifies a firm as a zombie if its interest coverage ratio (ICR) has been less than one for at least three consecutive years and if it is at least 10 years old. The second measure is narrower….and exploiting the fact that our database covers only listed companies for which we can observe stock market valuations, it adds the requirement that zombies should have comparatively low expected future growth potential. Specifically, zombies are required to have a ratio of their assets’ market value to their replacement cost (Tobin’s q) that is below the median within their sector in any given year….”