Giving zombie firms a second chance

June 22, 2022

The survival of less productive firms hampers the aggregate productivity growth in most developed economies as they consume resources that would be more productive elsewhere. Stimulated by the forbearance of creditors and inefficient insolvency regimes, the zombie phenomenon is generally believed to weaken business dynamism.

The paper analyses how the 2012 institutional reforms related to insolvency and prudential supervision of credit institutions, introduced by the Portuguese and European Authorities, have reduced the share of zombie firms in the economy, and how they have impacted the growth of aggregate productivity. Portugal is one of the OECD countries most affected by the zombie phenomenon. At the same time, the country has been particularly active in the adoption of the best international practices related to bankruptcy legislation.

Survival function of zombies before and after the reforms
Caption: Survival function of zombies before and after the reforms

The results show that the probability of remaining as a zombie declined after the introduction of the 2012 reforms (see figure), an indication of the success of the reforms.

The new institutional framework seems in particular to have a larger effect on recovery than on the exit transition. Firm size plays a major role in the way zombie incidence is reduced. For larger firms, solving financial distress is a complex matter and as a consequence the zombie status tends to persist. Smaller firms, in turn, having a higher share of secured debt (and less dispersed too), are more easily liquidated.

One of the main conclusions of the work is that not all zombies are unviable firms, and that an adequate institutional framework can increase the transition probability into reorganization and recovery. This approach seems to lead to a more desirable outcome, in comparison with the situation where zombies are forced to exit, thus destroying some valuable and promising projects.

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


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