A Zombie Firm is a company that continues to operate despite being unable to cover its debt servicing costs from current earnings over an extended period. These firms survive primarily due to ongoing support from lenders or investors, rather than through generating sufficient revenue or profits. Here’s a detailed explanation tailored for a UK audience:

1. Definition:
   • Zombie Firm: A zombie firm is a business that generates just enough revenue to continue operating and service its debt at a basic level but does not have sufficient profitability to invest in growth, innovation, or even fully cover its interest payments over the long term. These firms rely heavily on favourable lending conditions or financial support to stay afloat.
2. Characteristics of Zombie Firms:
   • Debt Dependence: They have a high level of debt and rely on ongoing loans or credit to manage their obligations.
   • Low Profitability: Their earnings are insufficient to cover interest payments and operational expenses fully.
   • Minimal Growth: They lack the financial capacity to invest in expansion, research, development, or other growth initiatives.
   • Prolonged Survival: They continue to operate over long periods despite financial weaknesses, often due to support from banks or government policies.
3. Causes of Zombie Firms:
   • Lenient Lending Practices: Banks and financial institutions may continue to extend credit to these firms to avoid recognising bad loans on their balance sheets.
   • Low-Interest Rates: Prolonged periods of low-interest rates make it easier for these firms to service their debt without addressing underlying profitability issues.
   • Government Support: Government bailouts, subsidies, or policies designed to preserve jobs and businesses can sometimes keep zombie firms alive.
   • Economic Downturns: Recessions or economic crises can turn previously viable firms into zombie firms due to sudden drops in revenue.
4. Impact on the Economy:
   • Resource Misallocation: Zombie firms tie up capital, labour, and other resources that could be more effectively used by healthier, more productive companies.
   • Market Distortion: They can distort competition by undercutting prices due to their reliance on external financial support, making it difficult for more efficient firms to thrive.
   • Financial Instability: The presence of many zombie firms can pose risks to the financial system, particularly if banks have large exposures to these non-viable businesses.
   • Innovation Stagnation: With limited capacity for investment, zombie firms contribute to lower levels of innovation and productivity growth in the economy.
5. Example:
   • A UK-based retail chain that has been struggling for years to generate sufficient profits continues to operate mainly due to repeated loans from banks. Despite low interest rates, the chain only manages to cover its interest payments but cannot afford to refurbish stores, invest in new technology, or expand its product range. The continued support from banks prevents its immediate collapse but does not address its fundamental lack of profitability and growth potential.
6. Legal and Regulatory Considerations:
   • Banking Regulations: Regulators may scrutinize banks for their lending practices to ensure they are not excessively supporting non-viable firms at the expense of financial stability.
   • Corporate Governance: Firms may need to adhere to corporate governance standards that promote transparency and accountability, potentially reducing the incidence of zombie firms.
   • Insolvency Laws: UK insolvency laws provide mechanisms for dealing with financially distressed companies, including restructuring options and administration procedures.
7. Best Practices for Mitigation:
   • Stringent Lending Criteria: Financial institutions should adopt stricter lending criteria and regularly assess the viability of their borrowers.
   • Restructuring and Turnaround Strategies: Encouraging firms to undergo restructuring or turnaround strategies can help address underlying issues and restore profitability.
   • Economic Policies: Policymakers can focus on creating a business environment that supports innovation, competitiveness, and the efficient allocation of resources.

In summary, a zombie firm in the UK context is a business that remains operational despite chronic financial underperformance, largely due to external financial support. These firms can negatively impact economic efficiency, innovation, and financial stability. Addressing the prevalence of zombie firms involves a combination of prudent lending practices, effective corporate governance, and supportive economic policies aimed at fostering a healthy, dynamic business environment.