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Corporate zombification poses significant risk to the European economy

Loose monetary policy and government bailouts in response to the pandemic have accelerated corporate zombification just as insolvencies have declined sharply and decoupled from economic developments. This poses significant risks to the European economy.


Zombie companies have increased significantly in recent years and there has been a greater persistence in zombification, with firms staying in a zombie state for longer. The classification of zombie companies is based on two criteria: (1) The interest coverage ratio (ICR), defined as earnings before interest and taxes (EBIT) divided by interest payments, is below one and (2) the ratio of the market value of assets to replacement cost (Tobin’s Q) is below the median for the sector.

“The extremely loose monetary policy of the European Central Bank in response to the negative effects of the financial crisis in 2009 was an important driver for the pre-pandemic increase in zombie companies. Permanently low interest rates, which are supposed to create incentives for more investment and thus economic growth, have also helped financially distressed companies survive,” says Kai Gerdes, Director at Scope Hamburg.
“Zombie companies would not be able to withstand rising interest rates or a deterioration in economic fundamentals. Under such circumstances, the credit risk of these companies would deteriorate, which could trigger a wave of insolvencies that potentially lead to a major risk for the banking sector,” notes Gerdes.
Low interest rates also have an important consequence for the assessment of credit risks: the generally positive discriminatory power of the interest coverage ratio (ICR) has lost significance. This means that a good ICR currently does not automatically translate into an indication of a good credit rating. For this reason, this financial ratio has a minor importance in the assessment of credit risks.

“We believe that the extensive Covid-19 bailouts to support the economy and mitigate the consequences of the pandemic have had a major impact on the emergence of more zombie companies and artificially kept alive companies that were already operating unprofitably before the pandemic or whose business models may no longer be viable after the pandemic ends,” says Gerdes.

Despite the negative economic impacts of the pandemic, corporate insolvencies decreased by 26.9% in 2020. With regard to this significant decline, Gerdes notes that corporate insolvencies “have completely decoupled from economic developments“.

“The question is not whether a wave of insolvencies will come but when and how severe it will be,” concludes Gerdes.

Analyst: Kai Gerdes

Media: Keith Mullin