The Mystery of Middle-and-Small Scaled Private Zombie Firms

From our previous research, we find that middle-and-small scaled private firms account for most of the zombie firms. We name it “the mystery of middle-and-small scaled private zombie firms”, which can hardly be explained by existing literature. This paper explains why these middle-and-small scaled private firms became zombies from a new perspective: contagion effect. Hard getting loans directly from banks, middle-and-small scaled private firms always take a mutual-guaranteed way of borrowing, with a close tie of capital and business between upstream and downstream firms. Once a firm has a financial crisis and becomes a zombie, connected firms have to provide it with credit funds or bank guarantees, which may make it more dangerous for connected firms to become zombies. Specifically, we give three channels through which contagion effects happen among middle-and-small scaled private firms: borrowing, crowding-out effect of labor and crowding-out effect of investment. We test our hypothesis using Chinese Industrial Enterprises database 1998—2013. Our research has important implications for dealing with zombie firms and promoting supply-side structural reform