Zombies? Growth Options, Heterogeneous Firms, and the Allocative Effects of Zombie Lending"

Abstract: 

We develop a model with firm dynamics, imperfect competition, and growth options. Firms borrow using credit lines offered by competitive lenders that can optimally provide zombie lending (that is, reducing the interest rate on borrowing below the risk free rate). We solve and calibrate the model and show that zombie lending is used in equilibrium to subsidise two very different types of firms: ``stagnant zombies'' previously borrowed to fund projects that are no longer feasible. They are offered zombie lending so that they can gradually reduce their debt and avoid default. ``high-potential zombies'' have growth options and borrow to pursue them. Zombie lending ``buys them more time'', in the hope they will become more profitable in the future and will thus be able to repay the debt. The main insight of the model is that while both types of zombie firms are consistent with the way such firms are usually identified in the empirical literature, they have opposite implications for misallocation and aggregate productivity and welfare. We use the model to propose novel criteria to identify the different zombie types and new testable predictions of their allocative effects: i) An increase in markup dispersion within industries should increase the share of zombie firms and the share of zombies that in the future recover and reach top quartile performance. ii) Sectors where zombies behave like high-potential ones should exhibit positive TFP responses to zombie prevalence, while those dominated by stagnant zombies should show declining productivity. Using firm-level data from Italian firms between 2007-2016, we provide robust empirical evidence confirming these predictions.