This month's featured article
Did COVID-19 create more zombie firms in Japan?
Gee Hee HONGIMF
ITO ArataSenior Fellow, RIETI
SAITO YukikoSenior Fellow (Specially Appointed), RIETI
With low levels of firm exits, it appears that Japanese firms have weathered the pandemic. However, aggregate firm exit rates mask developing corporate vulnerabilities due to: (i) weaker cleansing mechanism with the decline in the exit of unhealthy firms; and (ii) increased borrowing, especially in long-term debt. The pockets of vulnerabilities are concentrated in sectors most affected by the pandemic, with a sharp increase in the number of firms with solvency issues (“zombie firms”), which would have otherwise been healthy firms without the pandemic.
Two years have passed since the COVID-19 pandemic shock permeated the globe. The pandemic constituted a massive shock to the Japanese economy, as in other countries, posing a significant threat to the business continuity of firms. With timely and strong government support, firm exit rates have remained remarkably low and job losses associated with the pandemic have been contained. At the same time, the low level of firm exits raises concerns about the zombification of Japanese firms, to the extent to which the government support is allowing insolvent firms to continue, and the extent to which previously healthier firms became vulnerable after the pandemic shock.
In this column, using a firm-level dataset from Tokyo Shoko Research (TSR), a credit rating agency, on firm exits and balance sheets up to 2021, we document the impact of the COVID-19 pandemic on corporate exit patterns and debt structure. First, we examine the correlation between firm characteristics and firm exits before and after the pandemic shock. This addresses the question of which firms have exited in the past two years. In addition, we look at this correlation for different firm exit types (voluntary exit versus bankruptcy), taking advantage of the information available in the data. Second, using balance sheet information, we document the change in corporate debt structure. Using the definition of “zombie firms” introduced by Fukuda and Nakamura (2011, 2013), we identify firms that have built up corporate debt beyond their ability to repay.
In a recent paper (Hong et al., 2022), we find that the low level of firm exit rates indeed masks increased corporate vulnerabilities, especially in sectors that were most directly affected by the pandemic. Importantly, firm exit rates of financially weak firms declined during the pandemic, suggesting that the so-called cleansing mechanism, whereby a less productive firm exits to allow for a more productive firm to enter, has weakened. At the same time, the bankruptcy rate has declined for all firms, regardless of their financial conditions. Turning to the changes in corporate debt structure, we find that firms increased long-term borrowing as opposed to short-term borrowing. Corporate debt increased by 9.4 percent in 2020 at the aggregate level, but a substantial increase was concentrated in certain sectors, mostly exposed to the pandemic shock, but also in the manufacturing sector. The share of zombie firms rose sharply in the accommodation, personal services, and transportation sectors as well as in the manufacturing sector.
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