Recovery and exit of zombie firms in Portugal

May 7, 2021

This paper estimates that a 1% decline in the share of highly indebted and unprofitable mature firms (i.e. zombies) increases the average labor productivity by 3.1 percent.

In well-functioning markets, competition is expected to force zombie firms to restructure or exit. However, in many instances, these firms have a tendency to remain zombies. Aggregate productivity is therefore impaired by reduced allocative efficiency and negative externalities on investment and entrepreneurship.

This paper analyzes the factors that enable a zombie firm to recover, exit or remain in the same status. The empirical inquiry uses longitudinal data covering the entire set of companies operating in the manufacturing and service sectors in Portugal over the 2004-2017 period.

There is a large incidence of zombie firms in the Portuguese economy, with an average share over the sample period of 11% with the corresponding share of employment being 6% (see figure). The paper also finds that industries with a higher proportion of zombies exhibit lower levels of productivity. The analysis reveals that zombies are strongly entrenched, with a 69% probability of remaining in the same status in the following year, an indication of the presence of high barriers to recovery/exit or of the softness of the banking sector. Finally, the results show that operational and technological restructurings, downsizing and debt restructuring are crucial factors in stimulating zombie recovery.

An institutional framework that improves the efficiency of insolvency regimes is strongly recommended, while zombie lending should be discouraged. Restructuring and bankruptcy entail nevertheless sizeable welfare costs, and that should also be a matter of concern for policy makers.

Click here to go to the paper by Carlos Carreira, Paulino Teixeira, and Ernesto Nieto-Carrillo.