Signalling Theory

Signalling theory is used across a variety of disciplines and is applied to situations that assume imperfect information (information gaps) between parties and how information asymmetries are communicated (signalled). In the case of a company and a potential investor weighing up an investment decision, the theory can be applied to how a company (which has more proprietary information) is communicated (signalled) to an investor (who has less proprietary information). Signalling theory explores the incentives that drive the company’s (sender’s) modes of communication and communications strategy and the investor’s (receiver’s) ability and/or preparedness to read the signalling and act on it. Signalling can have a material impact on pricing in financial markets.