Signaling strategies in annual reports: Evidence from the disclosure of performance indicators Francesco Dainelli ⁎, Laura Bini 1 , Francesco Giunta 2 Department of Accounting and Economics, University of Florence, via delle Pandette 9, 50127 Florence, Italy abstract article info Keywords: Signaling theory Voluntary disclosure Performance indicators Business review In voluntary annual report communication, empirical results of signaling theory are contrasting, mainly owing to problems in disclosure measurements. We focus on a specific piece of incremental information and study the sig- naling strategies in annual reports by analyzing the disclosure of performance indicators that provide incremen- tal information. In this paper, we scrutinize the business review of a sample of 120 listed Italian companies for fiscal year 2010. After controlling for size, risk, and industry, our analysis confirms that the number of indicators published is positively related to firm profitability. Our results help clarify the signaling strategies in annual re- port communication. Operatively, our evidence can help regulators and standard setters to better discipline the communication of relevant and private information in annual reports, particularly performance indicators. © 2013 Elsevier Ltd. All rights reserved. 1. Introduction Market contractual relations reflect economic decisions that, when approached rationally, are based on the quality, reliability, and timeli- ness of information (Armstrong, Guay, & Weber, 2010; Grossman & Stiglitz, 1980; Laffont, 1989; Rasmusen, 1987). To reduce information asymmetries and avoid adverse selection mechanisms, managers must release information to present and potential investors. This assumption is supported by the signaling theory. In particular, firms that consider themselves undervalued by the market have incentives to signal their actual value by releasing private information. To be reliable, a signal has to convey relevant incremental information to market players (for all see Beyer, Cohen, Lys, & Walther, 2010). Thus, the signaling theory posits a positive relationship between a firm's performance and the level of its private information communicated to the market. Among different communication channels, the annual report is con- sidered the most reliable vehicle, even if not timely, for conveying infor- mation (Botosan & Plumlee, 2002; Eccles & Coleman, 1998; Francis & Schipper, 1999; Watts, 2006). To overcome the limitations of mandato- ry financial information and reduce the information asymmetries among investors, firms have begun to include an increasing level of dis- cretionary disclosure in annual reports over time (Deloitte, 2007; PricewaterHouseCoopers (PwC), 2008). Several studies have investigated these voluntary disclosures to confirm signaling strategies and empirical evidence shows conflicting results. Certain studies highlight a positive relationship between a firm's profitability and its level of disclosure (Gamerschlag, Moller, & Verbeeten, 2011; Haniffa & Cooke, 2002; Lim, Matolcsy, & Chow, 2007; Wang, Sewon, & Claiborne, 2008), while other literature finds no such relationship (Alsaeed, 2006; Cahan, Rahman, & Perera, 2005; Chau & Gray, 2002, 2010; Eng & Mak, 2003; Ho & Wong, 2001; Hossain & Hammami, 2009; Malone, Fries, & Jones, 1993; McNally, Eng, & Hasseldine, 1982; Meek, Roberts, & Gray, 1995; Patelli & Prencipe, 2007; Raffournier, 1995). There are two main causes for these inconclusive results. First, because these studies aim to investigate how corporate characteristics influence the amount of disclosure in- cluded in annual reports, they develop disclosure indexes that encom- pass different topics (see Botosan, 1997; Meek et al., 1995; Wallace & Naser, 1995). Assuming that different disclosure topics are managed using different communication strategies, these indexes might have obstructed the clear identification of signaling strategies. Moreover, the presence of disclosure items that are not considered to provide in- cremental value information (i.e., public information), probably con- tributes to obfuscate any signaling mechanism as well (Botosan, 1997; Chau & Gray, 2002, 2010; Lim et al., 2007; Meek et al., 1995). In order to overcome the limitations mentioned above and thus bet- ter understand signaling strategies, we focus on a specific piece of incre- mental value information–performance indicators–which represent the crux of the relationship between insiders and investors (see, among others: Gibson, 1987; Matsumoto, Shivaswamy, & Hoban, 1995; Amir & Lev, 1996; Behn & Riley, 1999; Accounting Standard Board (ASB), 2006; Coram, Mock, & Monroe, 2011). Since the beginning of the 1990s, performance indicators together with other narrative information have been identified as necessary inte- grative information that helps to improve the usefulness of annual reports for users (American Institute of Certified Public Accountants Advances in Accounting, incorporating Advances in International Accounting 29 (2013) 267–277 ⁎ Corresponding author. Tel.: + 39 0554374733; fax: + 39 0554374910. E-mail addresses: francesco.dainelli@unifi.it (F. Dainelli), l.bini@unifi.it (L. Bini), francesco.giunta@unifi.it (F. Giunta). 1 Tel.: +39 0554374689; fax: +39 0554374910. 2 Tel.: +39 0554374709; fax: +39 0554374910. 0882-6110/$ – see front matter © 2013 Elsevier Ltd. All rights reserved. http://dx.doi.org/10.1016/j.adiac.2013.09.003 Contents lists available at ScienceDirect Advances in Accounting, incorporating Advances in International Accounting journal homepage: www.elsevier.com/locate/adiac