Signaling
Principles of Finance glossary · Cost of Capital & Capital Structure
Definition
The use of observable actions (dividend changes, financing choices) to convey private information about firm quality.
Signaling in plain English
Signaling is about proving something you can't just say out loud. A company's managers know things outsiders don't — like whether the business is truly healthy — but simply claiming "we're doing great" is cheap and unconvincing, so instead they take an action that would hurt to fake. For example, raising the dividend (the regular cash payout to shareholders) signals real confidence, because a struggling company couldn't afford to keep that up. It's like a job applicant who, instead of just saying "I'm dedicated," finishes a hard unpaid trial project — the costly action sends a message that mere words can't.
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