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signalling hypothesis

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The idea that many actions taken by economic agents are motivated chiefly by the wish to send a positive ‘signal’ to other agents, rather than by their ostensible purpose. This can be a means of overcoming the problem of asymmetric information between transactors. For example, a business may choose to spend an ostentatious amount of money on advertising a new product – not because this is the most cost-effective form of publicity, but because a large outlay by the company signals its faith in the product to investors, distributors, and other stakeholders. Similarly, a generous dividend policy can be a means by which management signals its positive view of the firm's position and future prospects to the financial markets. In this case, such signalling is a means of overcoming the mismatch between the information available to managers and that available to shareholders. See also agency relationship.

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