Recovery and exit of zombie firms in Portugal

The resources sunk in zombie firms have risen over the last two decades, hampering productivity growth in developed economies. In this paper, we examine the recovery and exit of zombie firms among small- and medium-sized enterprises (SME), as well as the determinants of these transitions. To our knowledge, this is the first study on the determinants of the probability of a zombie recovering or exiting in a European context. The study also contributes to the discussion of the definition of zombie firms. Based on a panel of Portuguese manufacturing and services firms covering the 2004-2017 period, we do find a widespread presence of zombies. As expected, they are relatively less productive than non-zombies, while the probability of transition into recovery and exit is relatively low, which we interpret as evidence in favour of the presence of high barriers to firm mobility. In turn, the regression results show that downsizing and restructuring, as well as debt restructuring, are crucial in enhancing recovery of zombie firms. These are non-trivial results from the perspective of managers and policy makers. We performed several exercises using alternative definitions of zombie firms and estimation techniques and found that our findings are robust. Plain English Summary A 1% decline in the share of highly indebted and unprofitable firms (i.e. zombies) is estimated to increase the average labour productivity by 3.1 percent. Recovery of zombies in particular can be enhanced by downsizing and restructuring. Based on a very large panel of Portuguese small- and medium-sized manufacturing and services firms, covering the 2004-2017 period, we do find a widespread presence of zombie firms. Moreover, the chance of these firms to recover or exit is relatively low, an evidence of the presence of high barriers to firm mobility and resource misallocation. Our results have important managerial and policy implications: (1) a coordinated and holistic restructuring strategy (technological, operational and debt-related) is crucial to increase the likelihood of recovery of weak companies; (2) governments should formulate an adequate institutional framework in order to strengthen the selection of zombie firms, namely by designing more reallocation-friendly insolvency regimes and discouraging creditors to refinance unviable firms.