Better Is Better? Signaling Paradoxes in Performance-Based Advertising

Advertising signaling theory shows that costly advertising can serve as a credible signal of product quality (hereafter ad-signal ), provided that the effectiveness of advertising can be accurately measured. The rise of performance-based advertising, in which advertising is paid based on consumer actions, such as clicking on or purchasing through an ad link, presents challenges in measuring the effectiveness of advertising. Specifically, it becomes difficult to differentiate whether a consumer’s action is caused by ad-signal or the inherent product appeal. This leads to a critical question: how does this inaccuracy in evaluating advertising effectiveness affect the signaling role of advertising? This research analyzes how the inherent product reputation and the breadth of ad-signal reach impact the signaling role of advertising, uncovering two paradoxes under performance-based advertising: a higher product reputation does not necessarily help advertising to signal product quality (product reputation paradox), and a broader ad-signal reach can impede the signaling role of advertising (ad-signal reach paradox). We propose modified payment schemes to address both paradoxes. These insights contribute to advertising signaling theory and offer practical guidance for designing effective payment schemes under performance-based advertising.