Judicial inefficiency and the default of zombie firms

Using a large sample of European enterprises, we document that companies’ default probability is significantly larger when they experience negative end-of- the year equity (zombie status) in the year prior to default. Zombie firms are more likely to default in the short run in countries with more efficient judicial insolvency procedures. To establish a causal link between judicial efficiency and the default probability of zombie firms, we exploit a reform of the court districts in Italy that generates exogenous variation in trial lengths. This country-level analysis corroborates the findings of a cleansing effect of judicial efficiency that limits the persistence of zombie firms in the economy.