Facts, Fiction, and the Fourth Estate

• Date: 01 November 2004
• Author: William L. Anderson
• DOI: http://doi.org/10.1111/j.1536-7150.2004.00331.x
• Published date: 01 November 2004

Facts, Fiction, and the Fourth Estate

The Wa sh ington Post and “Jimmy’s World”

By WILLIAM L. ANDERSON*

ABSTRACT.This paper examines the reaction of the market to news

that the Washington Post had won a Pulitzer Prize for a story that was

demonstrably false. The reaction to the stock price of the Post as well

as the stock prices of other newspapers is examined using dummy

variables for two days, four days, and six days. The results show that

while the decline in the Post’s stock price was relatively small, the t-

statistics for all of the dummy variables are significant. The paper also

examines the McChesney (1987) hypothesis that the nature of the

newspaper business is such that it is difficult for the residual claimants

of the paper to receive the financial gains of important news stories.

These rents, he points out, are distributed to others. We look to see

whether or not residual claimants of that newspaper can be harmed

if that newspaper publishes a false story and receives large amounts

of bad publicity for its error.

Adam Smith in The Wealth of Nations outlined the basic conflict of

interests between owners of a firm and those who manage it or work

in its employ. He writes that “the directors of ...companies, being

the managers of other people’s money than of their own, it cannot

well be expected that they should watch over it with the same anxious

vigilance with which (owners) watch over their own” (1976, p. 741).

In his example of the agent-principal problem, Smith referred to

the East India Company, the Hudson’s Bay Company, and the Royal

African Company. Had he been alive in 1981, he might have included

the Washington Post. The system set up by the company’s principal

The American Journal of Economics and Sociology, Vol. 63, No. 5 (November, 2004).

© 2004 American Journal of Economics and Sociology, Inc.

*Professor William L. Anderson (banderson@frostburg.edu) teaches economics at the

College of Business of Frostburg State University in Frostburg, Maryland. He would

like to thank William F. Shughart, Fred McChesney, Michael T. Maloney, Henry

Thompson, John D. Jackson, T. Randolph Beard, Carl Hudson, and Jeffrey Yankow for

their assistance in preparing this paper. All errors are his own.

owners to monitor malfeasance on behalf of its reporters broke down

that year. The Post found itself in 1981 the “poster child” for jour-

nalistic hoaxes that would culminate with the world-famous news-

paper of Watergate fame having to return a Pulitzer Prize because the

honored story turned out to be fiction.

This paper explores the infamous Janet Cooke affair at the Post. I

first attempt to find if its admission that the Pulitzer-Prize-winning

story, “Jimmy’s World,” was a fraud caused an abnormal drop in the

stock price of the Washington Post Company, thus reducing the

wealth of residual claimants.

I

Agency Theory and Journalism

THE FIRST STEP IN ANALYZING the Janet Cooke affair at the Post is to

examine the actions of journalists through agency theory. The neo-

classical theory of the firm is built on the assumption that the firm is

a profit-maximizing enterprise. The firm uses resources efficiently and

is attuned to consumers’ wants in order to achieve that goal.

The owner-principal has two problems. The first is to monitor the

performance of each individual employee, and the second is to

reward that performance. In that regard, the job of the owner of a

newspaper to monitor reporters is not quite as difficult. Reporters

write stories, and it is relatively easy to determine the frequency and

popularity of those articles. It is less easy, however, to determine their

accuracy.

Like employees in other difficult-to-monitor situations, journalists

can capture rents. They do so by writing successful news stories,

according to McChesney (1987). He conducted statistical tests to find

whether or not the Washington Post profited financially from its exten-

sive coverage of the Watergate scandal, an event that was brought to

light largely through the Post’s efforts.

He concludes that while the residual claimants of the Post did not

receive abnormal returns from the newspaper’s Pulitzer-Prize-winning

coverage, the surge of public interest in Watergate news from the Post

created financial windfalls. These rents, however, were captured both

by advertisers who experienced a wider-than-anticipated audience for

966 The American Journal of Economics and Sociology