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Zombies in our Midst

Zombies in our midst


Since the 2008 recession, we have witnessed the rise of unusual economic creatures. Hiding in plain sight, they employ thousands of people in Europe and operate across almost all sectors of the economy. Yet, these apparently benign beings have a dark side, limiting domestic productivity growth and threatening to exacerbate a future economic downturn. They are the zombie firms.

What are zombie firms?

For such an evocative term, there is no one definition of what a zombie firm actually is. One view is that it’s a business which is unable to cover its debt servicing costs from current profits over an extended period[1]. Another definition describes it as any company receiving subsidized credit as a zombie[2]. We take a more nuanced approach, identifying companies where turnover is static or falling, profitability is persistently low, margins are being squeezed, cash and working capital reserves are limited, leverage levels are high, and where there’s a limited ability to invest in new equipment, products or processes. Not every zombie will display every single symptom, but a few early symptoms tend to indicate trouble ahead.

The rise in the number of zombie firms over the past decade has been precipitated by an unprecedented set of economic circumstances. The loose monetary policy environment over the past decade certainly accounts for much of it, allowing highly leveraged companies to make their repayments which, under more ‘normal’ economic circumstances, would be unaffordable[3].

There are, however, a number of other factors at play. For various reasons, lenders are exhibiting greater creditor forbearance. Increasingly, banks have taken a ‘wait-and-see’ approach to struggling businesses within their portfolios. Unconventional government policies during and following the economic downturn also encouraged banks to continue business lending. This can be seen through corporate insolvency levels which have been at historic lows for several years[4].

In previous recessions, businesses that were not productive enough would have ceased trading, being replaced in time with new dynamic companies and ensuring capital is invested most effectively in high-growth, high-productivity businesses. This time round, however, many of these businesses have been able to stagger on, generating just enough profit to continue trading, but without the innovation, dynamism or investment necessary to sustain bottom-line growth. This has created a drag on European productivity, which continues to lag our peers in the G7.

The risks to the wider European economy are very real, regardless of what the post-Brexit environment looks like. If interest rates rise, highly leveraged businesses may soon find that once-affordable borrowing will soon become difficult to repay. If the economy continues to stutter, these businesses with very little headroom will be left especially vulnerable to adverse market forces or a tightening of liquidity.

What types of businesses are impacted?

We started looking at companies listed on Euronext, using information from their most recent annual accounts. These companies represent the European’s largest businesses and provide a rich set of data for analysis.

We initially used two established definitions for a zombie firm: the interest cover ratio (the ‘wide’ definition) and further added Tobin’s Q, the divergence between book and market value (the ‘narrow’ definition)[6]. On the narrow measure, which includes Tobin’s Q, we identified that the number of zombie firms represents around 7.8 percent of listed European companies.

However, whilst these wide and narrow definitions allow for easy cross-border comparison, they are challengeable. For instance, low interest cover ratio may not, in itself, indicate a zombie firm if the sector typically is highly leveraged.

The point is illustrated by the examples of US electric car manufacturer Tesla and TV streaming behemoth Netflix, both of which could be classified as zombie firms under the global definition. They are both established businesses each turning over billions of dollars and generating very little in the way of cash or profits. Despite all this, it would be hard to classify either of these as zombies given their growth profiles.

Chart 1: Concentration of listed zombie firms in EU sectors

Source: Euronext, Refinitiv data source, KPMG analysis.

Luxembourg landscape and exposure

The rise of zombie firms, due to, among other factors, favorable interest rates, increases in collateralized loan obligations or loosening of lending standard (e.g. covenant-lite leverage loans), may also have a considerable effect on investment institutions in Luxembourg.

As the country with the second largest amount of funds registered, Luxembourg is exposed to potential economic impacts due to the continuously increasing number of private equity/debt houses. Debt funds, in particular, are steadily on the rise in Luxembourg, and predicted to grow even more as a result of favorable legislative developments such as the introduction of the RAIF (see below chart).

Chart 2: Debt funds in Luxembourg

Source: Euronext, Refinitiv data source, KPMG analysis.

Private debt funds are particularly interested in zombie firms as they are becoming more and more of an attractive alternative to traditional lenders. Since banking institutions face increasingly restrictive capital requirements (which obviously do not apply to investment funds), debt funds have proven to be a very popular alternative.

In this context, Luxembourg AIFMs/GPs need to be aware of the particular risks inherent to zombie firms. As described in the CSSF Frequently Asked Questions AIFMD (version 10, 9 June 2016), it is the responsibility of the AIFM (or, when applicable, of the AIF itself) to ensure the implementation of a robust and appropriate approach for their activities. The CSSF will evaluate on a case-by-case basis the approaches implemented by the AIFMs or the AIFs based on its approval and the ongoing supervisory process.

When it comes to investment strategy, whatever the risk profile of the fund, it is highly recommended for the portfolio manager to:

  • define appropriate Key Risk and Key Performance Indicators as to continuously monitor the performance and risks of zombie firms they have invested in. How?
    • Follow-up on the VIX index (avoiding unnecessary risks from the investors in periods of fear)
    • BCE interest rates (given the poor-quality loans granted, a slight increase of the interest rates could jeopardize the longevity of zombie firms)
    • Correlation between the entities within the portfolio (to prevent contamination from zombie firms to others)
  • monitor the proportion of zombie firms within the portfolio
    • actively introduced by acquisition of additional shares from such firms, or
    • passively when non-zombie firms become zombies

The initial and continuous assessments performed on the targeted investments should allow portfolio managers to draw out a heatmap/matrix guiding on the most robust companies to invest in. Whether risk-averse or risk-seeking, the remaining challenge lies in the standardization of the risk approach, defining the different thresholds and stating whether a given level should be considered low, medium or high.


Zombie firms are getting funded by non-traditional lenders: private equity/private debt funds. Although the private equity/ private debt may appear well-diversified (since it is invested in companies which, for instance, may be located in various countries, active in different industries, exposed to different currencies, etc.), the bottom line is that they all share one common and significant risk factor: the interest rates. If interest rates rise, all of those zombie firms are in trouble regardless of geography, sector, etc.

The main business stakes relevant to zombie firms today are related to valuation and risk management. Private equity and private debt players have to pay particular attention to ex-ante analysis so as not to be trapped in seemingly attractive investment opportunities which may embed hidden risks. Impacted portfolio managers need to ask themselves whether the targeted corporations are properly valued, have a robust cost structure as well as define key risk indicators in order to closely monitor the entities’ performance.

Whilst macro-economic adverse consequences from the rising amount of zombie firms are clear, the specific risks embedded in zombie companies remain uncertain, hidden and hard to identify. Analogously to the ESG trend, market players will rapidly need to raise awareness of this trend and converge toward adequate methodologies and tools to capture, screen and map the related risks. In this instance, a scoring scheme could be defined in order to ensure a consistent approach in the risk identification and risk measure throughout the private equity/debt universe.

[1] Europe and Luxembourg adaptions from the KPMG UK article on the topic [PDF | 1MB] (written by Yael Selfin and Blair Nimmo)

[2] See R Banerjee and B Hofmann, “The rise of zombie firms: causes and consequences”, BIS (2018), and AM McGowan D Andrews and V Millot, “The walking dead? Zombie firms and productivity performance in OECD countries”, OECD (2017).

[3] See Caballero, Ricardo J., Takeo Hoshi, and Anil K. Kashyap. 2008. "Zombie Lending and Depressed Restructuring in Japan." American Economic Review, 98 (5): 1943-77.

[4] The number of zombies has largely risen across the developed world. In the UK, the number of listed zombie firms fell between 2007 and 2010, and the level of employment in zombie companies fell further by 2013. But the proportion of capital tied up in zombie firms remained material, at 7.5% by 2013 (see R Banerjee and B Hofmann, “The rise of zombie firms: causes and consequences”, BIS (2018), and AM McGowan D Andrews and V Millot, “The walking dead? Zombie firms and productivity performance in OECD countries”, OECD (2017).  

[5] Although Creditors’ voluntary liquidations have started to rise since 2015.

[6] Our wide definition classified a company as a zombie if its interest coverage ratio was less than one in the last three years and the company was older than ten years; and the narrow definition added a third requirement that the company had its Tobin’s Q lower than the median for the sector, pointing to relatively low growth expectations.


Alan Picone
Partner Risk Advisory
KPMG Luxembourg
Phone: +352 22 51 51 72 39

David Capocci
Head of Alternative Investments
Phone: +352 22 51 51 51 10

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