Zombies in Finance

Definition

In finance, the term “zombie” refers to a company that is unable to generate enough profit to cover its debt servicing costs, relying on continued borrowing to stay afloat. These companies are often considered as being on the brink of bankruptcy but manage to survive through debt refinancing or other external support. Consequently, they may struggle to compete and invest in growth, potentially leading to a negative economic impact.

Phonetic

In the International Phonetic Alphabet (IPA), the phonetics of the keyword “Zombies in Finance” would be: /ˈzɒm.biz ɪn ˈfaɪ.næns/

Key Takeaways

1. Zombie companies, in a financial context, are firms that are unable to cover their debt servicing costs with their current earnings, leading to reliance on continuous refinancing and external sources for their continued existence.
2. These companies can threaten economic stability, as they can consume resources ineffectively, lower productivity growth, and potentially crowd out more productive investments by consuming financial resources that could be allocated to healthier companies.
3. One contributing factor to the growth of zombie companies is the prolonged period of low interest rates, as it becomes easier for them to refinance their debts and survive, despite being fundamentally unprofitable or unsustainable.

Importance

Zombies in Finance is an important term as it refers to companies that are essentially insolvent, but continue to operate due to the support of creditors, investors, or government bailouts. These companies often struggle to pay off their debts, generate a minimal profit, and lack the capacity to invest in growth. The existence of zombie companies is significant because it can lead to the misallocation of resources, stifle economic growth, and potentially destabilize the financial system. By artificially keeping these companies alive, resources like capital and labor are tied up, hindering the development of healthier, more productive firms. Moreover, the prevalence of such firms can reflect broader economic challenges or weaknesses within specific industries or the overall financial system. Thus, understanding zombies in finance is crucial for policymakers and market participants when addressing issues related to economic growth, financial stability, and market efficiency.

Explanation

Zombies in finance refer to companies that are financially struggling and unable to meet their debt obligations, thus barely keeping their operations alive. These companies may continue to exist in the market due to continuous refinancing options provided by their creditors. The purpose of classifying such companies as ‘zombies’ is to highlight entities that are essentially trapped in a financial limbo. These firms are not only unprofitable but also struggle to generate positive returns on their investments. Consequently, they cannot make strides towards growth, often becoming a drag on the economy and occupying valuable resources that might be better allocated to more profitable firms. In terms of usage, identifying zombie companies has become a significant factor in financial decision-making processes, particularly for investors and market regulators. By analyzing financial metrics such as interest coverage ratios and profitability levels, investors can steer clear of investing in these entities, minimizing the risks associated with potential bankruptcy. On the other hand, regulators and policymakers closely monitor zombie firms to maintain a healthy financial ecosystem and prevent systematic risks. Furthermore, understanding the reasons for the emergence of these companies can also shed light on structural issues that might be prevalent within certain industries, prompting the need for policy reforms or regulatory measures to encourage more sustainable and efficient economic growth.

Examples

In finance, the term “zombies” refers to companies that are unable to generate enough revenue to cover their interest expenses or pay off their debt, hence surviving on excessive borrowing or external financial support. Here are three real-world examples: 1. Polaroid Corporation: In the late 1990s and early 2000s, Polaroid Corporation struggled to adapt its business model and product line as the popularity of digital photography increased. Even though the company was unable to generate enough revenue to cover its debts, it kept borrowing money to fund its daily operations. The company finally filed for bankruptcy in 2001, becoming a classic example of a zombie company. 2. Kodak: Kodak, once a dominant player in the photography industry, faced declining sales and mounting debt in the early 21st century as digital technology rapidly replaced traditional film-based photography. Despite cost-cutting measures and efforts to diversify its product lineup, Kodak was unable to generate enough cash flow to cover its debt obligations. In 2012, the company filed for bankruptcy but eventually managed to restructure its core business. Today, Kodak operates as a more focused and smaller company, providing print and imaging products for businesses worldwide. 3. Japanese Zombie Banks: Japan experienced an economic downturn during the 1990s, which led to the formation of several ‘zombie banks.’ These banks, weighed down by excessive bad debt, were not lending to potential borrowers, which contributed to the stagnation of the Japanese economy. The Bank of Japan (BoJ) and Japanese government opted to support these struggling financial institutions with loans and other measures rather than letting them fail. This situation created artificially prolonged corporate survival for several businesses, negatively impacting the overall Japanese economy for many years.

Frequently Asked Questions(FAQ)

Related Finance Terms

• • Corporate Zombies
  • Debt Restructuring
  • Interest-Only Loans
  • Insolvency
  • Bankruptcy

Sources for More Information

• Goldman Sachs
• Investopedia
• Wikipedia
• Harvard Business Review