As the proportion of struggling firms that cannot even cover interest expenses reaches an all-time high, a new analysis suggests that large struggling companies are hindering investment and employment among smaller, healthier businesses. Experts warn that the continued presence of these struggling firms in the market is exacerbating financial risks, making restructuring urgent.
A report released by the Bank of Korea's Economic Research Institute on June 15 indicates that for every 1 percentage point increase in the share of struggling firms, the investment and employment growth rates of healthy companies within the same industry decline by 0.14 to 0.18 percentage points, a trend that persists for two to three years.
Struggling firms are defined as those with an interest coverage ratio (ICR) below 1 for three consecutive years among companies observed for over five years. Last year, the proportion of struggling firms approached 40%, marking the highest level since statistics began in 2013.
Using comprehensive administrative data that includes both externally audited and non-audited firms, the Economic Research Institute found that while the absolute number of struggling firms is higher among small non-audited companies, large externally audited struggling firms dominate in terms of total assets and financial liabilities within the economy.
As of 2023, externally audited struggling firms accounted for 4.7% of total corporate assets, compared to just 2.3% for non-audited struggling firms, which has remained stable over time. These large struggling firms are prioritizing bank loans and government policy funds.
The market presence of these large struggling firms leads to a "congestion effect" that hampers healthy companies. Small non-audited firms, which often face weak financing conditions and limited access to bank loans or bond markets, are particularly affected and become the "small victims" of this situation. This congestion effect is especially pronounced in non-manufacturing sectors that rely heavily on domestic markets and have low export concentrations.
Lee Kyung-tae, Deputy Director of the Bank of Korea, explained, "As the share of struggling firms rises, healthy companies are unable to invest and hire, which ultimately leads to a causal relationship that decreases total factor productivity (TFP) and profitability across the industry."
Simulation results predict that if about 25% of non-competitive struggling firms were to exit the market, TFP could increase by 0.2% and value-added by 0.35%, reflecting the positive effects of economic restructuring. However, the interconnectedness of transactions suggests that approximately 0.3% of healthy firms could also face insolvency during the exit process of struggling firms.
The Bank of Korea recommends strengthening institutional frameworks to facilitate the timely exit of struggling firms through measures such as the Corporate Restructuring Promotion Act. It suggests prioritizing externally audited firms with high asset and financial liability ratios due to their associated risks.
However, the report emphasizes the need to avoid past practices of targeting only specific industries, such as shipbuilding, shipping, and construction, for restructuring. The Deputy Director stated, "Focusing solely on specific industries risks overlooking struggling firms in other sectors. Therefore, a consistent principle that considers the characteristics of each industry should guide restructuring efforts."
He added, "Rather than simply looking at financial indicators for exits, it is crucial to distinguish between firms that temporarily fall below an ICR of 1 during investment in research and development or market expansion and genuinely non-competitive struggling firms."
* This article has been translated by AI.
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