Too embarrassed to ask what is a zombie company?

A low interest-rate environment enables companies to reduce their interest payments, but it can also create "zombie companies". But what is a zombie company?

In popular fiction, zombies are the walking dead.

You probably already knew that. But you may be surprised to hear that economics has zombies too.

A “zombie company” is one that makes just enough money to stay afloat, and to pay the interest on its debts. However, it doesn’t make enough money to expand or invest, or to reduce the level of its debts.

In other words, it’s neither alive nor dead – it’s just shambling along, dependent on the ongoing indulgence of its lenders to survive.

This leaves it highly vulnerable to the slightest economic shock.

What makes a zombie company? It has to be reasonably mature. Young firms are often loss-making, but that’s because they are at the “invest and build” stage of development.

The company also has to be chronically loss-making rather than in temporary difficulties – in other words, there is no obvious way out of its situation.

A 2018 study from the Bank for International Settlements (which is basically a central bank for central banks) found that the percentage of zombie firms around had risen from just 2% in the late 1980s to 12% by 2016.

The biggest factor driving this rise was the long-term slide in interest rates seen in recent decades.

Lower interest rates enable struggling companies to reduce their interest payments, allowing them to shuffle on for a bit longer. A low interest-rate environment also means investors are more willing to lend to such companies, simply to make any sort of return on their money.

However, this desperate “reach for yield” simply enables the survival of more zombie companies. Eventually this can be a big problem for the economy as a whole, as it makes the overall economy more fragile.

Some argue that zombies also impair the vital process of “creative destruction”. If low quality companies plod on rather than going bankrupt, it means that they crowd out younger, potentially more dynamic companies that don’t have the same access to resources that they do. As a result, the economy becomes less efficient and productivity falls.

To learn more about the debate around zombie companies and what to do about them, subscribe to MoneyWeek magazine.

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