Zombie Firms and Debt Accumulation: A Theoretical Framework and Chinese Experience

23 Pages Posted: 7 May 2020

See all articles by He Zhu

He Zhu

Peking University

Fan He

Shanghai Jiao Tong University (SJTU) - Antai College of Economics and Management

Shennan Wang

University of International Business and Economics

Qianlin Ye

Peking University

Chen Liang

University of Chicago

Date Written: November–December 2019

Abstract

In recent years, as China has grappled with rising debt and broad economic restructure, the prevalence of zombie firms has become a critical problem. This paper provides a theoretical framework illustrating the rationale behind the occurrence of zombie firms from the perspective of banks. We develop differential equations to model a bank's expectation and the ex ante estimate that underlies its decision to refinance an insolvent borrower. An optimistic expectation is essential in zombie lending and is intrinsic to the countercyclical pattern of zombie firms. Our model also predicts that debt can build up to an unsustainable level if recovery of profitability is sluggish or the initial debt burden is too high. Examining the Chinese experience of zombie firms over 2007–2017, this paper highlights two findings. First, the share of zombie firms among Shanghai and Shenzhen A‐share listed companies demonstrates a countercyclical pattern. Second, the positive correlation between zombie share and debt accumulation across manufacturing sectors sheds light on the link between zombie firms and the rising corporate debt in China. To deal with the “zombie” problem, the government should carefully weigh its policies to avoid further distortions because the occurrence of zombie firms may be inevitable and impossible to eliminate.

Keywords: bank credit, China's debt risk, debt accumulation, over‐capacity, zombie firm

JEL Classification: D24, E22, G21, G32, O16, O53

Suggested Citation

Zhu, He and He, Fan and Wang, Shennan and Ye, Qianlin and Liang, Chen, Zombie Firms and Debt Accumulation: A Theoretical Framework and Chinese Experience (November–December 2019). China & World Economy, Vol. 27, Issue 6, pp. 104-126, 2019, Available at SSRN: https://ssrn.com/abstract=3594703 or http://dx.doi.org/10.1111/cwe.12298

He Zhu (Contact Author)

Peking University ( email )

No. 38 Xueyuan Road
Haidian District
Beijing, Beijing 100871
China

Fan He

Shanghai Jiao Tong University (SJTU) - Antai College of Economics and Management ( email )

No.535 Fahuazhen Road
Shanghai Jiao Tong University
Shanghai, Shanghai 200052
China

Shennan Wang

University of International Business and Economics

10 Huixindongjie, Chaoyang District
Beijing, 100029
China

Qianlin Ye

Peking University

No. 38 Xueyuan Road
Haidian District
Beijing, 100871
China

Chen Liang

University of Chicago ( email )

1101 East 58th Street
Chicago, IL 60637
United States

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