UK insolvency regime tackles ‘zombies’

The UK’s insolvency regime has been commended by the OECD for its streamlined approach in tackling so-called ‘zombie’ firms, in a report looking at how to accelerate the restructuring or exit of weak firms in order to improve productivity growth

The OECD study found the prevalence of zombie firms is closely related to weaknesses in the banking system and insolvency regimes. It argues that reviving productivity growth will partly depend on the policies that restore banking health and effectively facilitate the exit or restructuring of weak firms, while simultaneously coping with any social costs that arise from a heightened churning of firms and jobs.

Zombie firms are defined as longstanding firms that have persistent problems meeting their interest payments, and the OECD analysis suggests their number are rising. In Italy, for example, the share of the industry capital stock sunk in zombie firms rose from 7% to 19% between 2007 and 2013.

New OECD indicators suggest that there is much scope to improve the design of insolvency regimes to accelerate the restructuring or exit of weak firms and thus revive productivity growth.

For example, insolvency reforms that reduce barriers to corporate restructuring and the personal cost associated with entrepreneurial failure could translate into a decline in the zombie capital share of at least 9 percentage points in Spain, Italy or Portugal – countries where the zombie capital share stood at 28%, 19% and 16% in 2013, respectively. 

The report states: ‘The insolvency regime in the UK for example, entails relatively low personal costs to failed entrepreneurs and barriers to restructuring, plus a number of provisions to aid prevention and streamlining.’

If Italy adopted the UK's approach to insolvency, it would make capital in the country four percentage points more effective, the OECD calculates.

The study says the UK insolvency regulation encourages economic activity, by allowing unsuccessful entrepreneurs to start on new ventures within a year. This compares with five years in Estonia and Hungary.

The OECD also says zombie firms are more likely to be connected to weak banks, suggesting that zombie congestion partly stems from bank forbearance – i.e. the tendency for weak banks to bet on the resurrection of failing firms. It says this underscores the importance of a more aggressive policy to resolve non-performing loans, accompanied by complementary reforms to insolvency regimes.

Confronting the Zombies: Policies for Productivity Revival is here.

Report by Pat Sweet

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