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Beyond the Twilight Zone: The Restructuring and Resurrection of Zombie Firms

Responses to financial crises can have the unfortunate effect of creating “zombie” firms, companies whose operating profits are insufficient to cover their debt service. These companies would probably have gone bankrupt without the forbearance of banks or regulators or other types of government or lender support, but their rise reduces economic productivity, limits healthy firms’ growth, and deters the creation of new firms (Caballero et al, 2008; McGowan, Andrews, and Millot, 2017).

The question of what factors enable certain zombie firms to survive while others fail, however, has not yet been addressed in literature. I contend that not all zombies are equal – zombies that have undertaken, or could undertake, effective restructurings can be nursed back to life. Restructuring is a complex and multi-dimensional process that involves a range of actions affecting operations, capital structure, and governance. In a new paper, I investigate which restructuring activities are more likely to allow firms to recover from their zombie status. I expect restructuring activities that improve operational efficiency, rather than financial restructuring alone, to be a key determinant of whether zombie firms can successfully revive.

I first investigate whether certain large accounting charges can be used to predict effective restructuring. Many zombie firms are created when expansionary monetary and fiscal policies try to offset economic downturns by providing low-interest rates and subsidies. Creditors and investors have higher risk tolerance during economic downturns, and zombie firms can take advantage of that with large asset write-downs or other non-recurring restructuring charges. I contend that such charges can enable firms to reduce inefficiencies and focus on ongoing restructuring efforts.

Alternatively, managers may overstate restructuring charges to increase future earnings. This discretionary behavior may reflect managerial expectations that investors will ignore the excessively large charges, especially for troubled firms such as zombies. The earnings management components of restructuring charges are unlikely to improve operational efficiency. Following Bens and Johnston (2009) to estimate the discretionary component of restructuring by deducting expected restructuring charges as inferred by economic fundamentals, I find that, while restructuring charges, in general, can revive zombie firms, excess restructuring (earnings management) has no effect on zombie revival.

The primary explanations for the existence of zombies include the “evergreening hypothesis,” which suggests that banks roll over problem loans for insolvent borrowers to avoid large loan write-downs or presumably more costly Chapter 11 bankruptcy (Sekine, Kobayashi, and Saita, 2003; Peek and Rosengren, 2005; and Andrews and Petroulakis, 2019). However, such financial relief or restructuring contributes to the rise of zombie firms but might not necessarily contribute to their recovery. Due to lending forbearance and credit-subsidized behavior, zombie firms are held back from the costly restructuring necessary to restore operational efficiency and regain profitability. I thus divide restructuring activities into two types: business restructuring and financial restructuring. I find that business restructuring resolves the fundamental operational issues of zombie firms and generates revenues that could revive them, whereas financial restructuring by itself may not contribute to zombie revival.

Measuring restructuring activities at the firm level is challenging. A single accounting item of restructuring charges contains noisy information, such as hidden reserves for future use, and cannot fully capture the whole pictures. Previous literature largely uses news reports to infer restructuring (see Gilson et al., 1990, among others). I confront this challenge by using the pre-trained Bidirectional Encoder Representations from Transformers (BERT) to infer restructuring activities from zombie firms’ annual 10-K reports. Using a comprehensive and context-specific dictionary to calculate business restructuring and financial restructuring, I find that business restructuring is significantly positively related to zombie revival, controlling for firm characteristics and year, using industry fixed effects. In contrast, financial restructuring generally has no effect on zombie revival using the same specifications.

I define a zombie firm’s revival as moving from zombie to non-zombie status. Next, I examine the duration of their zombie status. I find that firms with more extensive business restructuring descriptions in their financial reports are more likely to recover from their zombie status and tend to stay in zombie status for shorter periods. The effect is muted for zombie firms with more extensive financial restructuring activities. My findings are robust to different specification checks with and without industry fixed effects.

Finally, I study how effective restructuring contributes to the strengthening of efficiency. Business restructuring cuts unnecessary costs and refocuses on productive and profitable operations to restore efficiency and generate positive cash flows. I validate my primary findings by documenting that recovered zombie firms improve their operating efficiency and restore profitability compared with non-recovered zombie firms.

My study contributes to several strands of literature. First, it adds to the growing literature on zombie firms. Prior studies focus on the causes and consequences of the prevalence of zombie firms (e.g., Banerjee and Hofmann, 2018). However, the issue of zombies has attracted very little attention in the accounting literature. To date, surprisingly, the factors that revive zombie firms have still not been closely studied. I emphasize that zombie firms should not be treated uniformly. Contrary to the conventional wisdom that zombie firms stem from lenders’ forbearance, I find that business restructuring activities can provide valuable information to predict the formation and evolution of zombie firms, whereas financial forbearance-motivated restructuring cannot contribute to the revival of zombie firms, implying the excessive leniency of credit markets might delay the revival of zombie firms. To the best of my knowledge, my paper is the first to document the role of restructuring activities in the revival of zombie firms. In addition, I further contribute to the literature on the determinants of zombie firms by focusing on the duration of firms’ zombie status. I conduct survival analysis using both non-parametric and parametric methods.

I also provide new insights into the contrasting roles of financial and business restructuring in the proliferation of zombie firms. The existing theories of zombie lending largely rely on regulatory capital requirements (Caballero et al., 2008; Peek and Rosengren, 2005). Recent studies highlight the importance of the borrowing firm’s reputation in contributing to the existence of zombie lending (Hu and Varas, 2021). I improve our understanding by demonstrating that forbearance might not help zombie firms to recover. However, operational restructuring actions taken by zombie firms can mitigate their problems.

Finally, my study extends the literature on textual analysis of corporate disclosures in accounting. The application of textual analysis in accounting research has notably increased over the past two decades because, aside from accounting numbers, disclosures are critical to understanding various business and corporate financial issues. Bochkay et al. (2022) suggest that accounting researchers should increase the use of machine learning, especially deep learning, that can detect richer semantic features of words in textual analysis. My study takes advantage of ground-breaking advancement of machine learning in natural language processing by building on the FinBERT model to create a dictionary of restructuring terms to infer business and financial restructuring activities (Yang et al., 2020; Huang et al., 2020). To the best of my knowledge, my study is the first in accounting to employ this novel approach to infer business and financial restructuring activities and study their quantitative implications.

These findings have potential implications for managers, capital regulators, practitioners, and policy makers in preventing the creation of zombie firms. In particular, the results support the argument that the revival of a zombie firm requires managers to have effective strategies. Expansionary monetary policy gives banks an incentive to relax lending standards and extend credit to risky borrowers. Excessive leniency in providing credit may prolong their zombie status. Future research should examine how governments could coordinate their monetary policies with efficient restructuring and insolvency regimes, and how lenders could scrutinize their contracts and encourage firms to carry out business restructuring that improves operational efficiency.


Andrews, D., and F. Petroulakis. 2017. Breaking the Shackles: Zombie Firms, Weak Banks and Depressed Restructuring in Europe. ECB Working Paper (2240).

Banerjee, R., and B. Hofmann. 2018. The Rise of Zombie Firms: Causes and Consequences. BIS Quarterly Review.

Bens, D. A., and R. Johnston. 2009. Accounting Discretion: Use or abuse? An Analysis of Restructuring Charges surrounding Regulator Action. Contemporary Accounting Research 26 (3): 673–699.

Bochkay, K., Brown, S.V., Leone, A.J. and Tucker, J.W., 2022. Textual Analysis in Accounting: What’s Next?. Available at SSRN.

Caballero, R. J., T. Hoshi, and A. K. Kashyap. 2008. Zombie Lending and Depressed Restructuring in Japan. American Economic Review 98 (5): 1943–1977.

Gilson, S. C., K. John, and L. H. P. Lang. 1990. Troubled Debt Restructurings. An Empirical Study of Private Reorganization of Firms in Default. Journal of Financial Economics 27 (2): 315–353.

Huang, A., Wang, H. and Yang, Y., 2020. FinBERT—A Deep Learning Approach to Extracting Textual Information. Available at SSRN 3910214.

Hu, Y. and Varas, F., 2021. A theory of zombie lending. The Journal of Finance, 76(4), pp.1813-1867.

Loughran, T., and B. Mcdonald. 2011. When Is a Liability Not a Liability? Textual Analysis, Dictionaries, and 10-Ks. Journal of Finance 66 (1): 35–65.

———. 2016. Textual Analysis in Accounting and Finance: A Survey. Journal of Accounting Research 54 (4): 1187–1230.

Lynch, D. J. 2020. Here’s One More Economic Problem the Government’s Response to the Virus has Unleashed: Zombie firms. The Washington Post.

McGowan, M. A., D. Andrews, and V. Millot. 2017. Insolvency Regimes, Zombie Firms and Capital Reallocation. OECD Economics Department Working Papers 4 (2): 10–18.

Peek, J., and E. S. Rosengren. 2005. Unnatural Selection: Perverse Incentives and the Misallocation of Credit in Japan. American Economic Review 95 (4): 1144–1166.

Sekine, T., K. Kobayashi, and Y. Saita. 2003. Forbearance Lending: The Case of Japanese Firms. Monetary & Economic Studies, 2(1).

Yang, Y., Uy, M.C.S. and Huang, A., 2020. Finbert: A pretrained language model for financial communications. arXiv preprint arXiv:2006.08097.

This post comes to us from Christine Liu, a PhD candidate at the University of Toronto’s Rotman School of Management. It is based on her recent article, “Beyond the Twilight Zone: The Restructuring and Resurrection of Zombie Firms,” available here.

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