Debt Signaling

AAA

DEFINITION of 'Debt Signaling'

A theory that states that an announcement regarding a firm's debt can be used as a signal of the stock's future performance. A company announcement regarding the issuance of debt is said to signal positive news, while an announcement that states that debt will be taken on at a future date is said to be a negative signal about the company.

BREAKING DOWN 'Debt Signaling'

When a company agrees to take on more debt, it is making a commitment to pay interest on the debt. In doing so, it is showing that the company is in a stable financial situation. Conversely, when the amount of future debt is reduced, investors may see this as a sign that the company is unable to make its interest payments and is in a weak financial situation.

Studies regarding debt announcements and the signals they provide have shown statistically significant results that this theory does actually occur in real life. Subsequently, the theory has been used by proponents of the inefficient market hypothesis.

RELATED TERMS
  1. Behavioral Finance

    A field of finance that proposes psychology-based theories to ...
  2. Market Psychology

    The overall sentiment or feeling that the market is experiencing ...
  3. Signaling Approach

    The idea that insiders have information not available to the ...
  4. Inefficient Market

    A theory which asserts that the market prices of common stocks ...
  5. Random Walk Theory

    The theory that stock price changes have the same distribution ...
  6. Insider Information

    A non-public fact regarding the plans or condition of a publicly ...
Related Articles
  1. Active Trading Fundamentals

    Understanding Investor Behavior

    Discover how some strange human tendencies can play out in the market, posing the question: are we really rational?
  2. Active Trading

    What Is Market Efficiency?

    The efficient market hypothesis (EMH) suggests that stock prices fully reflect all available information in the market. Is this possible?
  3. Active Trading Fundamentals

    Efficient Market Hypothesis: Is The Stock Market Efficient?

    Deciding whether it's possible to attain above-average returns requires an understanding of EMH.
  4. Fundamental Analysis

    Explaining the Central Limit Theorem

    Central limit theorem is a fundamental concept in probability theory.
  5. Fundamental Analysis

    Examining Mexico's Trillion-Dollar GDP

    Examining the gross domestic product growth and composition of Mexico, the second largest economy in Latin America
  6. Fundamental Analysis

    What Causes Inflation in the United States

    Inflation is the main catalyst behind U.S monetary policy. But what causes this phenomenon of sustained rising prices? Read on to find out.
  7. Fundamental Analysis

    Is India the Next Emerging Markets Superstar?

    With a shift towards manufacturing and services, India could be the next emerging market superstar. Here, we provide a detailed breakdown of its GDP.
  8. Term

    Estimating with Subjective Probability

    Subjective probability is someone’s estimation that an event will occur.
  9. Investing Basics

    Understanding the Modigliani-Miller Theorem

    The Modigliani-Miller (M&M) theorem is used in financial and economic studies to analyze the value of a firm, such as a business or a corporation.
  10. Economics

    Explaining Kurtosis

    Kurtosis describes the distribution of data around an average.
RELATED FAQS
  1. What is the utility function and how is it calculated?

    In economics, utility function is an important concept that measures preferences over a set of goods and services. Utility ... Read Full Answer >>
  2. How can I use a regression to see the correlation between prices and interest rates?

    In statistics, regression analysis is a widely used technique to uncover relationships among variables and determine whether ... Read Full Answer >>
  3. How do I calculate a modified duration using Matlab?

    The modified duration gauges the sensitivity of the fixed income securities to changes in interest rates. To calculate the ... Read Full Answer >>
  4. How do I calculate the rule of 72 using Matlab?

    In finance, the rule of 72 is a useful shortcut to assess how long it takes an investment to double given its annual growth ... Read Full Answer >>
  5. How do I calculate the standard error using Matlab?

    In statistics, the standard error is the standard deviation of the sampling statistical measure, usually the sample mean. ... Read Full Answer >>
  6. How do I adjust the rule of 72 for higher accuracy?

    The rule of 72 refers to a time value of money formula that investors use to calculate how quickly an investment will double ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Depreciation

    1. A method of allocating the cost of a tangible asset over its useful life. Businesses depreciate long-term assets for both ...
  2. Recession

    A significant decline in activity across the economy, lasting longer than a few months. It is visible in industrial production, ...
  3. Bubble Theory

    A school of thought that believes that the prices of assets can temporarily rise far above their true values and that these ...
  4. Stock Market Crash

    A rapid and often unanticipated drop in stock prices. A stock market crash can be the result of major catastrophic events, ...
  5. Financial Crisis

    A situation in which the value of financial institutions or assets drops rapidly. A financial crisis is often associated ...
  6. Election Period

    The period of time during which an investor who owns an extendable or retractable bond must indicate to the issuer whether ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!