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Dividends and signalling hypothesis

Akerlof (1970) showed that in a situation of informational asymmetry - within the market of lemons - exchanges are not possible. In order to allow these exchanges and to make it possible to discriminate good cars from lemons, the author uses the term of signal, i.e. information able to allow someone to distinguish the quality of different cars. From there, Spence (1974) then Riley (1975) specified the conditions which should be fulfilled to reach a signalling equilibrium (i.e. how information allows for assessing the ‘fair’ value of each car). Indeed, a few assumptions must be checked to obtain a steady and efficient balance. The cost of the signal must be negatively correlated with the real value of the ‘signalled good’. A marginal increase in signal has to involve a marginal increase in the real value. Finally, expectations of the investors must be checked ex-post. As a consequence, managers should be able to send to shareholders relevant signals aimed at convincing them that their decisions are the right ones and are willing to increase the value of their firm.

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