Xiaomin Fan

Excessive support from banks and governments to poorly‐performing firms, making them zombie firms, distorts financial resources—a common factor in firm innovation. Using a large sample of Chinese industrial firms, this paper investigates the impact of zombie firms on the innovation of healthy firms. The results indicate that the prevalence of zombie firms reduces the patent output of healthy firms and seriously jeopardises innovation. Endogeneity analyses and robustness checks validate the results. Further analysis reveals that zombie firms distort the credit resources of healthy firms, especially those that are state‐owned or in high‐tech industries, thereby reducing innovation output. However, the higher financial marketisation of provinces can alleviate this negative effect. This study contributes to an understanding of the negative consequences of zombie firms due to the distortion of credit and provides some policy implications for the disposal of zombies to promote high‐quality economic development.