Signaling financial performance with alternative performance measures

Abstract

We apply signaling theory to explain the voluntary disclosure of alternative performance measures (APMs) in earnings announcements’ press releases of European firms. As APMs are voluntary measures that are not audited or regulated they can be used by management to strategically communicate positive information about the firm’s performance. We consider that the use of APMs to strengthen the performance signal varies both with capital market pressures and product market competition. While capital markets give management incentives to signal high performance, competition can either increase APM performance signaling to show competitive advantage or reduce APM signaling if the signaling costs are too high. We hand-collect the APMs disclosed by the largest industrial European firms. We find that the strength of the APM’s signal increases with capital markets pressure, i.e. when firms fail to meet their earnings benchmarks with accounting earnings. Moreover, the strength of the signal is positively associated with the level of industry competition but only for firms with good performance. In a competitive environment the cost of disclosing dishonest signals are too high for the low performing firms.