Facts, Fiction, and the Fourth Estate

Date01 November 2004
AuthorWilliam L. Anderson
Published date01 November 2004
Facts, Fiction, and the Fourth Estate
The Wa sh ington Post and “Jimmy’s World”
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.
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
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

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