The death of “zombie” companies in a higher interest rate environment has been a topic of much discussion in recent years. A “zombie” company is defined as a firm that is unable to generate enough revenue to cover its debt and interest payments. These companies, which have been propped up by low interest rates, may struggle to survive in an environment where rates are rising.
When interest rates are low, companies can borrow money relatively cheaply and use it to finance operations and growth. This can be beneficial for companies that are struggling to generate enough revenue to cover their expenses, as it allows them to continue operating even if they are not generating a profit. However, as interest rates rise, the cost of borrowing money also increases, making it more difficult for these companies to service their debt.
As interest rates rise, companies that were previously able to survive despite not generating a profit may no longer be able to do so. This can result in a number of negative outcomes for both the companies themselves and the broader economy. For example, companies that are unable to generate enough revenue to cover their debt and interest payments may be forced to lay off employees, reduce investment, or even go bankrupt. This can lead to job losses, reduced economic activity, and a decline in overall economic growth.
In addition, as “zombie” companies struggle to survive, they may be forced to sell assets at fire-sale prices, which can lead to a decline in asset prices and further economic downturns. Furthermore, companies that are unable to generate enough revenue to cover their expenses may be forced to cut back on investment, which can slow down economic growth and lead to a decline in productivity, at least in the short term.
It’s worth noting that the death of “zombie” companies in a higher interest rate environment is not a new phenomenon, and it has happened many times throughout history. However, as interest rates have been historically low for an extended period of time, there are concerns that the number of “zombie” companies has increased significantly, and the potential impact of their failure on the economy is a concern. Some key points to consider as to why “zombie” companies face this challenges in raising interest rate environments:
- High debt levels: Zombie companies often have high levels of debt, and as interest rates rise, the cost of servicing that debt becomes increasingly difficult. As a result, these companies may be forced to default on their loans, leading to bankruptcy.
- Lack of profitability: Zombie companies often struggle to generate enough revenue to cover their expenses, and as interest rates rise, this problem can be exacerbated. If a company is not generating a profit, it may not be able to raise the capital it needs to continue operating.
- Unsustainable business models: Many zombie companies have business models that are not sustainable in the long-term, and they are only able to survive because of low interest rates. When interest rates rise, these companies may find that their business models are no longer viable.
- Reduced access to credit: As interest rates rise, the cost of borrowing money increases, and companies may find it more difficult to access the credit they need to finance operations and growth. This can make it difficult for zombie companies to raise the capital they need to continue operating.
- Increased competition: Companies that were previously able to survive despite not generating a profit may find themselves facing increased competition as interest rates rise. This can make it difficult for zombies companies to attract and retain customers.
- Regulatory pressure: Some industries may be subject to increased regulatory pressure, and zombies companies may be unable to meet new standards, leading to bankruptcy.
- Lack of innovation: Zombies companies may not be investing in research and development and may not be able to compete with companies that are investing in new technologies or business models.
- Market changes: The market may have changed and the demand for the product or service the company is providing is no longer there.
The above raises the question, “are there any benefits to zombie companies going out of business and closing their doors? In our opinion, there definitely are benefits to zombie companies shutting down:
- Resource reallocation: When zombies companies close their doors, resources such as capital, labor, and assets that were tied up in the unproductive company can be freed up and reallocated to more productive uses. This can lead to increased economic growth and efficiency.
- Innovation: The closure of zombies companies can create space for new and innovative companies to enter the market, leading to increased competition and innovation.
- Increased productivity: Zombies companies are often not generating a profit, and their closure can lead to increased productivity in the economy as a whole.
- Improved market efficiency: The closure of zombies companies can lead to an improvement in market efficiency, as resources are allocated to more productive uses.
- Better allocation of credit: When zombies companies are no longer able to access credit, it can be freed up and allocated to companies with more sustainable business models.
- Investors benefits: Zombies companies can be a drag on the performance of a portfolio, by closing their doors, it can free up capital for more productive investments.
- Consumer benefits: The closure of zombies companies can lead to increased competition and better products and services for consumers.
- Reduced burden on government: Zombies companies can often require government support, such as subsidies or bailouts, by closing their doors, it reduces the burden on government finances.
It’s worth noting that the closure of zombies companies can also have negative consequences, such as job losses and reduced economic activity in the short-term. However, in the long-term, the reallocation of resources to more productive uses can lead to increased economic growth and efficiency.
In conclusion, the death of “zombie” companies in a higher interest rate environment can have significant negative consequences for both the companies themselves and the broader economy in the short term. As interest rates rise, companies that have been propped up by low interest rates may struggle to survive, leading to job losses, reduced economic activity, and a decline in overall economic growth. On the other hand, the death of “zombie “companies in the long-term can bring a range of benefits to the economy. The reallocation of resources to more productive uses can lead to increased economic growth and efficiency, innovation and increased productivity. The market efficiency is improved, with better allocation of credit and improved opportunities for investors. Consumers can also benefit from increased competition and better products and services. Additionally, it can reduce the burden on government finances. While the closure of zombies companies can have negative consequences in the short-term, such as job losses and reduced economic activity, the long-term benefits can outweigh the costs.