A Theory of Financial Media

In this paper we aim to better understand the economic role of financial journalists. Although there is a growing body of empirical research showing that financial journalists reach a broad swath of investors and that their reporting can affect trading in financial markets, the existing theoretical literature provides little insight into the specific economic role of financial journalists. Hence, our understanding of the equilibrium interactions between the financial media, investors, and firms is somewhat limited.

In our model, we consider a financial journalist who is strategic in both selecting what firm announcements to report on as well as the extent to which she clarifies to her readers the economic importance of these firm announcements. We start with the basic premise that some investors only follow financial announcement made by firms if these announcements are picked up and written about by a financial journalist. In practice, thousands of U.S. firms file 10-K statements with the SEC, free for the world to see, and yet few individual investors have the time to read each statement. For this reason, a financial journalist sifts through the many announcements made by firms and reports on those that she finds to be of greatest value to her readers.

The strategic behavior of the financial journalist implies that she will focus her reporting on announcements that yield the greatest benefit to her readers. This means that more informative announcements are more likely to get reported, and announcements that are more obfuscated by the firm are less likely to be reported. Hence, obfuscation occurs despite the fact that, if she chooses to report on a firm, she tries to clarify the announcements as thoroughly as possible to minimize her readers’ exposure to obfuscated announcements (for example, she can fact-check a dubious statement or she can re-word a sensational passage).

Our model generates the following three main results. First, more extreme firm announcements (both positive and negative) are more likely to be covered by the media than mundane announcements. Second, negative firm announcements are less likely to be covered relative to positive firm announcements because the journalist anticipates negative announcements to be more highly obfuscated by firms. Third, the presence of a financial journalist leads the firm to engage in more obfuscation which results in stock prices that are too high, on average. This happens because the firm will sometimes use the media’s spotlight to sugarcoat its fundamental value. However, we show that despite this positive bias in stock prices, the presence of a financial journalist always increases the informational content of stock prices.

Overall, our paper takes a first step towards a more complete understanding of the role of financial news. In particular, we highlight both the bright and the dark side of financial media. On the one hand, they identify and clarify firm announcements to certain financial market participants which would remain unaware otherwise.  On the other hand, they also represent a conduit that allows the firm to reach a set of less sophisticated traders with their potentially obfuscated announcements which, in turn, deteriorates the quality of information the media can report.