Zombies aren’t just taking over the streets these days. Their imprints are very present in stock quotes, and perhaps more so in Canada.
The definition generally used is that of the Organization for Economic Co-operation and Development (OECD). Companies are considered zombies if their revenues are less than their interest payments for three consecutive years and they are at least 10 years old. The number of these undead is increasing. This omnipresence is possibly underestimated by all the government support for income protection and by the payment deferral policies of financial institutions at the height of the pandemic. And recent studies show that their presence in the Canadian economy was possibly one of the highest in the world even before the outbreak of COVID-19.
Post-COVID data is not yet available. But there is concern at the Bank of Canada that another risk for the economy could come from the potential increase in the number of these moribund or artificially kept alive companies. The drop in the number of insolvency files filed which was noted in the first months of the pandemic despite the great economic slowdown could indicate an increased “zombification” of businesses in Canada, she indicated. The central bank then measured that the share of highly indebted companies as a percentage of the number of companies reached 16.6% in the last quarter of 2021 compared to 12.5% in the third of 2020.
However, since then, a return to a certain reality seems to be taking shape. Data from the Office of the Superintendent of Bankruptcy indicates that during the 12-month period ended August 31, 2023, the number of corporate insolvency filings increased by 36.7% compared to the corresponding period ended August 31, 2023. August 31, 2022. The number of bankruptcies jumped by 32.8% and that of debt settlement proposals by 50.5%.
On the side of the Quebec government, we recognize that public support can be important to reduce insolvency in the short term and to contain the collapse of aggregate demand during periods of major financial shocks. But “untargeted policy support combined with lax macroprudential and supervisory measures and insufficient insolvency frameworks can delay necessary creative destruction, with negative consequences for long-term productivity growth.”
In other words, this pandemic support helped businesses cope with the consequences of the pandemic, but it also helped extend the lives of businesses that would otherwise have left the market.
Let’s look at the numbers. In Canada and other advanced economies, the share of zombie companies has increased in recent decades. Worse, recent studies show that this share in Canada could potentially be the highest in the world, wrote Statistics Canada. In a census by the International Monetary Fund (IMF), Canada ranks sixth in the world for the period 2000-2021 in terms of the percentage of zombie companies that its economy contained. We are talking about a weight of 12% over the period considered.
2018 data from the Toronto Stock Exchange reveals that 16% of companies could be considered zombies. Other studies in 2020 indicate that Canada has the highest share of zombies (around 30%) among 14 OECD countries. Or that the proportion of zombies increased from around 3% to around 25% between 1980 and 2018.
Small downside
However, everything must be put into perspective. These studies are based only on companies listed on the stock exchange. They also indicate that two-thirds of Canadian zombies are found in sectors exposed to commodity prices, including 75% in metal mines. “Their samples exclude private companies under Canadian control, which represent more than 99% of all businesses in Canada,” notes Statistics Canada. With this expanded spectrum, the share of zombies in all companies oscillates between 5% and 7%, significantly lower than that of 18% to 36% of listed companies listed on the stock exchange.
In the IMF ranking, Canada would thus move from 6th to 23rd in the world over the period 1997-2020.
Productivity drop
Nevertheless, the trends imply a growing importance of weak companies that do not exit the market. And if the share of zombies among all companies has been decreasing since 2011, that among companies listed on the stock exchange has continued to increase. These zombie companies have grown over time, with their overall share of capital and employment increasing from approximately 3.1% and 3.6% in 2002 to 8.3% and 5.3% in 2019, respectively.
In other words, we are talking about a slowing down of the “process of creative destruction” intended to be harmful. The literature shows that these companies on life support can hinder the reallocation of resources, exacerbate labor shortages, and limit the growth of healthy companies in their sector. They are less productive, more indebted, invest less and harm the growth prospects of healthy companies within their sector. These companies monopolize more and more resources over time.
In total, it was measured that they increasingly reduced overall productivity in Canada, by more than 5% in 2019, highlights Statistics Canada. Nothing less !