In his latest note, Eoin Murray, Head of Investment at Hermes Investment Management, discusses zombie firms:
In the movies, the only way to kill a zombie is to destroy its brains by slicing off its head, ideally with a chainsaw, samurai sword or something else equally dramatic.
In real life, the killing of zombie firms is much less histrionic, but equally as effective. With Halloween upon us, I thought it would be timely to look at these so-called zombie firms – as did the Bank of International Settlements (BIS), which recently released a paper 1about them. Like the characters after which they are named, zombie firms are creatures that really should have shuffled off to the next realm some time ago. Instead of embracing death, they soldier on, usually wreaking havoc on the rest of society.
We have a glut of zombie firms in 2018, due to such an extended period of low interest rates which have allowed companies that would normally have defaulted on their debt repayments, to have lingered on indefinitely. Like in the movies, these zombie firms do not grow, mature or offer anything meaningful to the economy at large, and seem impervious to the number of rocks and shocks thrown at them. The BIS says this has been a growing problem since the late 1980s and is a drag on productivity.
Imagine a zombie sitting at your desk, attempting to carry out your role. Even on your most unproductive day in the office, it is likely you would get more done than them. The problem is compounded because these zombie firms hold back investment and employment growth in more healthy companies, against whom they compete for resources, effectively jamming up competition. This is not what any major economy needs right now.
According to the BIS report, their fragility also puts policy-makers in a tricky position, as they know an interest rate rise could kill many of them off, triggering significant unemployment. No one would wish to make such an unpopular decision which could cause such pain. However, help may be just around the corner.
As I have mentioned before, a recession could be on its way. While it will impose some pain on innocent bystanders – there’s never been a movie where only the bad guys are dispatched – it could help deal with our zombie firm problem. These companies are only able to survive in times of relative financial balminess. Much of the impact of the last crisis was cushioned by financial tinkering from regulators and central banks, meaning these zombies staggered on when they really should have met their maker.
The bottom line is when interest rates eventually start to rise, the impact could be less painful if it helps these firms find their final resting place – resulting in an overall positive impact on the economy. Like any horror film, it is always darkest before the dawn, and the slaying of these zombie firms will unfortunately hit the labour market in the immediate aftermath.
However, to get rid of these zombies that are clogging up the economy is ultimately a good thing in the long run and should see it return to healthy productivity growth.
That is, until the inevitable sequel…Happy Halloween!
- 1  The rise of the zombie firms: causes and consequences, Bank of International Settlements (BIS) https://www.bis.org/publ/qtrpdf/r_qt1809g.pdf