‘The corporate bankruptcy wave will get even uglier’ (2023), ‘Why the Fed is to blame for the boom in zombie companies’ (2022), and ‘Bank of England warns on corporate default risk’ (2023). These are just a few headlines that express growing concerns about corporate distress as central banks reverse one and a half decades of cheap money. But how many firms in distress are there really around the world? How did the share of such firms develop during the past 18 years? And how does corporate health compare across countries?
Existing studies are often not suited to answer these questions because they focus on only one narrow definition of corporate distress, they do not track firm performance over time, or they focus on only one economy and therefore lack comparability.
Our approach aims at overcoming these shortcomings: The Crux of Capitalism database provides three measures of corporate performance for about 40,000 firms in 21 sizeable economies since 2005 that are updated regularly. First, we calculate the interest coverage ratio (ICR), i.e., the ratio of operating income before depreciation to total interest and related expenses, which is a common ‘zombie’ indicator. Second, we compute the Altman Z’-score, a well-established indicator for the likelihood of bankruptcy. Third, we estimate each firm’s economic profits to see if it is unable to cover the opportunity cost of the capital it deploys. Four findings on the state of global corporate distress follow.
First, the share of firms worldwide in or close to corporate distress in 2022 surprised us. About 33% of firms around the world had an ICR below 1, which is taken by many to indicate zombie firm status. Meanwhile, almost 11% had negative Z-scores, which signals a heightened likelihood of bankruptcy, and 44% of firms generated economic losses; 3.5% destroyed more than $100m.
“Assessments of corporate distress often consider single metrics and tend to not track firm performance over time.”
If we only look at those firms that underperformed on these criteria in both 2021 and 2022, these percentages naturally drop. The shares of firms with insufficient means to pay their interest expenses, companies with negative Z-scores, and value-destroying firms fell to 25%, 8%, and 28% respectively. The fact that these percentages are lower than those in the last paragraph reveals the sizable dynamics in and out of corporate distress and that it is worth following the health of individual firms on an ongoing basis.
Second, on the ICR metric, the shares of firms in or near corporate distress fluctuate considerably over time. The share of zombie firms jumped during the Global Financial Crisis and in the first year of the COVID pandemic. Subsequently, loose monetary policy appears to have lowered the share of zombies. A similar response can be found for the Z-score and in our economic profits measure. Looking back, however, we note the share of firms with elevated bankruptcy risk remained stable during the entire 2012-2020 period, and the share that destroyed value fell during the US Federal Reserve Board’s 2015-2019 hiking cycle and the COVID crisis.
Third, these metrics vary significantly across our 21 economies. For 2021-2022, for example, the share of firms, which were in distress according to our ICR criterion varied between 8% in Japan and 56% in Canada. Japanese corporates were, in fact, the ‘healthiest’ on all three metrics presented here. Australian and Canadian firms, on the other hand, showed a high likelihood of corporate distress on all three measures. Dutch companies, in turn, featured among the least healthy according to the ICR criterion, but among the most solid ones when looking at Z-scores and economic profits instead. The Dutch example demonstrates that the ICR (zombification), the Z-score (bankruptcy risk), and economic profits (value creation) contain different pieces of information about corporate distress.
Fourth, our findings are very much in line with others. Altman et. al. (2021), for instance, find the 2021 shares of firms with a three-year moving average for the ICR below 1 and for the Z-score below 0 to be about 21% and 9%, respectively (in the world’s 20 largest economies). They also document the highest signs of distress in recent years for Australian and Canadian firms and the lowest for Japanese. Banerjee and Hofmann (2022), who use the same two-year ICR condition as we do but also require Tobin’s Q to be below the sector median, find a 15% zombie share for 2017 (for 14 economies).
As they normalize fiscal and monetary conditions, policymakers are walking a tightrope between terminating firms on life support and reviving viable ones. Saving firms with unfavorable ICRs but favorable other indicators is an approach worth considering. With our regularly updated data, analysts and officials are better placed to assess corporate distress at the firm, sectoral, and national levels.
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