Oct 11th 2001
Signalling is used in many markets, wherever a person, company or government wants to provide information about its intentions or strengths indirectly. Taking on debt might signal that a company is confident about future profits. Brands send valuable signals to consumers precisely because they are costly to create, and thus will not be lightly abused by their creators. Advertising may convey no information other than that the firm can afford to advertise, but that may be all a consumer needs to know to have confidence in it. Perhaps advertising, as a signal, is not money entirely wasted, as some economists argue.
The theory of signalling can also help to explain why companies pay dividends, even though they are less tax-efficient than share-price rises in compensating investors. Dividends, under the signalling theory, serve as a way of highlighting a strong profit outlook.
http://www.economist.com/node/813705
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