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VoxEU Column Productivity and Innovation

When zombies are not zombies

Much attention has been paid recently to ‘zombie’ firms as indicators of a misallocation problem that dampens productivity growth. It has been commonly assumed that the rise of zombies has been caused by accommodative monetary policy and behaviour of financial institutions. This column uses standard dynamic theory of the firm and firm-level register data from Finland to argue that changes in zombie incidence are not that alarming when a distinction is made between growing and downsizing firms and the entry and exit of firms to zombie status is explicitly considered.

Following the global financial crisis, poorly performing firms labelled as ‘zombies’ have attracted considerable attention (e.g. Acharya et al. 2019, Adalet McGowan et al. 2018, Banerjee and Hoffman 2018). The underlying idea is that a set of firms permanently fail to be profitable, and these zombies create a burden to other firms and the financial sector, as well as to the government which may also support these unviable firms by means of accommodative policies.

Zombie firms are commonly identified by measures based on their ability to cover their debt service costs from current profits, possibly augmented by some other condition, over a rather narrow time frame (e.g. Adalet McGowan et al. 2018). Thus, the measures of zombie incidence do not well correspond to idea of permanent failures. Rather, the measures are consistent with a static model of firm behaviour.

Changes in zombie incidence look considerably less alarming when the growth potential of firms is explicitly considered. Building on a dynamic model of firm entry and exit (e.g. Hopenhayn 1992, Hopenhayn and Rogerson 1993) and using register-based micro data from Finland (1999–2019), we challenge claims of a secular increase in zombie incidence driven by more persistent survival of non-viable firms (e.g. Adalet McGowan et al. 2018, Banerjee and Hoffman 2018).

Viable firms also have spells of weak performance

The definition of a zombie firm should capture non-viable firms that persistently survive in the market even though economic grounds warrant their exit. It should thus not only account for the prolonged weak performance of a firm (often defined by a low interest coverage ratio, or ICR), but also separate truly distressed firms from viable firms experiencing temporarily low earnings. Start-ups, before starting to generate their own income, may have high ‘burn rates’ as they spend aggressively on investment, labour, and R&D. In later stages of a firm’s life cycle, large investments or acquisitions may lead to a temporarily heavy debt and interest burden relative to earnings.

Future income and costs determine viability in a dynamic setting

In a recent paper (Nurmi et al. 2022) we make use of a dynamic model of firm entry and exit to show why some firms may at first sight look like zombies if the interest coverage ratio is used in identifying these firms. In a dynamic setup, firm survival does not only depend on its current returns; the firm’s exit decision is forward-looking. The expected future value of a firm is a key issue in zombie identification, as it determines whether the firm is likely to recover from losses accumulated during a spell of weak performance. Growing and downsizing firms differ crucially in this respect.

Negative current profits and remaining in the market without being labelled a zombie can be justified when the firm’s future expected present value is positive, the more so the higher the latter is. This naturally depends on (the present value of) future net income, which for growing and investing firms is more promising than for downsizing firms. But various costs, including fixed costs and adjustment costs, also play an important role.

Several general features arising from the model are relevant in understanding the zombie phenomenon. Firm exit or remaining in the market depends on the persistence of a productivity shock, since each new productivity draw changes a firm’s profitability relative to fixed costs. In addition to fixed costs, rigidities in the firm’s adjustment to productivity shocks are relevant for the zombie phenomenon. Firms adjust their scale to both positive and negative productivity shocks, but the cost of adjustment relative to their continuation value is more crucial for downsizing firms. As Decker et al. (2016) emphasise, employment responses are instant in the absence of adjustment costs, i.e. firms immediately reach their optimal scale. In the presence of adjustment costs, rescaling production is sluggish. Depending on these costs, firms may be on an adjustment path (possibly as zombies) for an extended time. Adjustment costs dampen the firm’s responsiveness to productivity shocks, thereby reducing both job creation and job destruction. Such rigidity may generate zombies in the firm population.

Exit costs are, of course, particularly relevant if bankruptcy is looming. Also, entry costs may be relevant if the entrepreneur intends to return to business activity after a bankruptcy. In the case where the firm faces an ICR below one and bleak future returns, an alternative to bankruptcy is obviously some sort of zombie status where the firm would try to adjust it output to the breakeven level. But that may not be immediately possible due to adjustment costs (which may apply to both labour and capital). If there were no adjustment costs, the firm would simply adjust the scale to the level that provides a sufficiently high ICR, and we would not observe any zombies.

Thus, when we wonder why zombie-type firms seem to exist, we should not only look at the current income and interest expenses but also at the future prospects of the firm and the relevant costs of entry, exit, and adjustment of scale. Exit costs are probably very much related to firms’ insolvency regimes and costs (McGowan et al. 2017).

Table 1 Importance of various costs on firms’ continuing decision 

Table 1 Importance of various costs on firms’ continuing decision

Misinterpreted zombies: Growing and recovering firms

We conduct an empirical analysis on zombie dynamics and demographics using annual firm-level data from the Financial Statement Statistics and the Business Register of Statistics Finland (1999–2019).  Instead of merely examining changes in the stock of zombies, we study the flows of firms into and out of zombie status that underlie the fluctuations in zombie incidence and decompose the zombie exit margin into exits out of the market and exits back to health.

Using the model as a guide, we augment the common ICR-based zombie definition (e.g. Adalet McGowan et al. 2018) with a forward-looking element that requires zombies to be non-growing firms. This separates true zombies from growing firms with temporarily weak earnings, which are misidentified as zombies in common definitions.

For the prospects (growth/downsizing) of a firm, there is no readily available variable or measure that could be derived from the available financial statement data. But we make use of the idea that the firm’s growth of employment could provide us such a measure (here, we use the idea of Syverson 2011 in explaining the fundamental difference between growing and declining firms). After all, if a firm decides to grow (employment growth is a decision that firms control endogenously), then this growth reveals the firm’s own private assessment of its expected future profitability. Thus, employment growth serves well as proxy for the expectations of the future value of the firm.

Our findings suggest that zombie incidence is considerably lower than indicated by earlier studies (Figure 1). We find that a third of firms that were labelled as zombies by the common ICR-based definition are in fact growing companies in our data. Indeed, zombie firms, as commonly defined in the literature, are often not truly distressed firms so much as growing companies with temporarily weak performance measures.

Figure 1 Share of shrinking and growing firms with ICR < 1 for at least three consecutive years, 2001–2019

Figure 1 Share of shrinking and growing firms with ICR < 1 for at least three consecutive years, 2001–2019

Moreover, over half of the firms we observe exiting zombie status returned to health. This high recovery rate among growing firms suggests that viable firms may exhibit weak performance measures due to temporary factors such as restructuring or periods of heavy investment. Although occurring at a lower rate, recoveries of downsizing true zombies suggests that the presence of zombies may be a natural part of firm dynamics in which the flow of earnings relative to interest payments in a firm varies over time. As a response to their weak performance, these firms take downsizing measures to restore profitability and promote recovery.

Figure 2 Zombie entry and exit rates, 2002-2018

Figure 2 Zombie entry and exit rates, 2002-2018

Furthermore, changes in zombie incidence are driven by cyclical zombie entries, not a secular decline in zombie exits as popular narratives suggest (Figure 2). Nor do we find evidence from the Finnish data that zombie firms would benefit from lower interest rates. The interest rate margin vis-à-vis non-zombie firms has systematically been positive. Of course, this does not exclude the possibility that banks would have had extra tolerance with these weakly performing firms for other reasons (e.g. Hoshi 2006).

Policy implications

We find that the identification of zombie firms by the common ICR-based definition gives a misleading estimate of the size of zombie population, as the definition fails to account for the forward-looking nature of the exit decisions of firms. Accounting for the expected future value of a firm and separating growing firms from zombies, we find that zombie incidence is considerably lower and more stable than commonly thought.

Our analysis therefore suggests that the purported high and rising incidence of zombie firms may be less alarming than commonly thought. Our results further indicate that more emphasis should placed on policies aimed at improving the efficiency of markets particularly in terms of bankruptcy and insolvency legislation, and various costs in adjusting the firm size. After all, zombies rather reflect these often-neglected semi-institutional elements in the market mechanism. Policies should tackle these issues instead of considering options for public support or financial regulation.

Authors’ note: The opinions expressed in this column are those of the authors, and do not necessarily reflect the views of Statistics Finland, the Bank of Finland or the Eurosystem.


Acharya, V V, T Eisert, C Eufinger and C Hirsch (2019), “Whatever it takes: The real effects of unconventional monetary policy”, Review of Financial Studies 32: 3366-3411.

Adalet McGowan, M, D Andrews and V Millot (2017), “Insolvency regimes, zombie firms and capital reallocation”, OECD Economics Department Working Papers 1399.

Adalet McGowan, M, D Andrews and V Millot (2018), “The Walking Dead? Zombie Firms and Productivity Performance in OECD Countries”, Economic Policy 33: 685-736.

Banerjee, R N and B Hofmann (2018), “The rise of zombie firms: causes and consequences”, BIS Quarterly Review, September.

Hopenhayn, H A (1992), “Entry, Exit, and Firm Dynamics in Long Run Equilibrium”, Econometrica 60(5): 1127-1150.

Hopenhayn, H and R Rogerson (1993), “Job Turnover and Policy Evaluation: A General Equilibrium Analysis”, Journal of Political Economy 101(5): 915-938.

Hoshi, T (2000), “Naze Nihon wa Ryudosei no Wana kara Nogarerareainoka?” [“Why is the Japanese Economy Unable to Get Out of a Liquidity Trap?”], in M Fukao and H Yoshikawa (eds),  Zero Kinri to Nihon Keizai [Zero Interest Rate and the Japanese Economy].

Hoshi, T (2006), “Economics of the Living Dead”, Japanese Economic Review 57: 30-49.

Nurmi, S, J Vanhala and M Viren (2022), “Are zombies for real? Evidence from zombie dynamics”, International Journal of Industrial Organization 85, 102888.

Syverson, C (2011), “What Determines Productivity?”, Journal of Economic Literature 49(2): 326-365.