Unfinished business: Zombie firms among SME in Japan’s lost decades

Abstract The “soft budget problem,” by which banks loosen their lending stances toward long-term client firms despite worsening business conditions, has been widely discussed in the field of financial studies. In Japan, this problem has attracted attention particularly in connection to so-called “zombie firms,” financially weak firms sustained by discounted interest rates and evergreen lending which have become a major research and political interest in recent years. In this article, we focus on zombie firms among small and medium-sized enterprises (SME), a corporate category that has hitherto received less consideration in the discussion about Japan’s zombie firms. We find that: (1) many zombie firms exist among SME and that the zombie firm ratio increases as firm size decreases; and (2) some zombie firms eventually emerge from zombie status among SME. In other words, zombie firms are likely problematic from the view of the efficiency of the industries to which they belong. But when one considers that many zombie firms achieve revival, it would seem inappropriate to uniformly promote their elimination. Since ending zombie status seems to directly imply market exit for many SME, it is important to conduct preliminary screening to prevent the creation of zombie firms in the first place.