Working Paper Series in Economics and Institutions of Innovation,
Royal Institute of Technology, CESIS - Centre of Excellence for Science and Innovation Studies

Abstract: This paper explores how sales and employment for knowledge intensive consulting firms are correlated. I apply theory on cash flow-investment sensitivities, mostly applied to manufacturing firms, to a less capital intensive part of the economy. Therefore the knowledge intensive consulting sector is investigated but instead of analyzing the investment in plant and machinery this analysis regards the investment in skilled employees. The argument of Kaplan & Zingales (1997) regarding low cash flow-investment sensitivity being a sign of financial distress is applied. The main result is that firms less likely to be financially constrained display 60 percent higher sales-employment sensitivities than firms more likely to be financially constrained. The results are estimated from a sample comprising 23,500 Swedish knowledge intensive consulting firms.

Keywords: Incomplete markets; asymmetric information; knowledge intensive business services; economic development

JEL-codes: D52; D82; L84; O16

23 pages, September 9, 2008

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