An Open IPO Window Will Save Investigative Journalism

In 2016, Mother Jones published an explosive account of what it’s like to work as a private prison guard. It was a classic piece of investigative journalism: four months of full-time under-cover work, leading to a polished, incisive piece that combined a smart 35,000 foot-view with plenty of harrowing on-the-ground detail.

It had a major impact, too: within months, the Justice Department announced that it would no longer contract with private prisons. (A move the current administration rescinded.)

This, you might think, is what journalism is for. But it’s certainly not what media companies are paid for. Per the editor:

Wow, a -6,900% profit margin! Series A, here we come!

OK, that was a cheap shot, but there is a financial angle here. Investigative journalism generally doesn’t pay very well. As media companies have lost their monopolistic traits and faced more market competition — as social media and search have unbundled them from a single publication into articles that get mixed into the Content Casserole — investigative journalism, with its subpar unit economics, has declined.

It doesn’t help that companies targeted by investigative journalists have sued. Your typical budget-conscious media outlet owner is not especially interested in paying endless legal fees to avoid seven-figure judgments. (Especially when, as happened in the ABC/Food Lion case, the trial reveals that the story was partially the result of selective editing, and that the journalists involved actively encouraged the behavior they were trying to draw attention to.)

Despite the financial pressures, there’s one kind of investigative journalism that’s thriving. Let’s return to that private prison story. Here’s a chart of Geo Group, a large operator of private prisons, from June through September, 2016:

Pop quiz: can you identify when the private prison ban was announced?

Suppose you’re an investment analyst looking at Geo Group in early 2016. Here’s what you might think: this business is profitable and throws off lots of cash, but there’s a risk of adverse PR.

Heck, the company discloses these risks. In their 2015 10-K, the risk factors section helpfully notes that “We depend on a limited number of governmental customers for a significant portion of our revenues. The loss of, or a significant decrease in revenues from, these customers could seriously harm our financial condition and results of operations.” They elaborate later: “Public resistance to the use of public-private partnerships for correctional, detention and community based facilities could result in our inability to obtain new contracts or the loss of existing contracts, which could have a material adverse effect on our business, financial condition and results of operations.”

They literally call out potential bad PR: “Adverse publicity may negatively impact our ability to retain existing contracts and obtain new contracts.”

GEO had about 74m shares outstanding at the start of 2016. It wouldn’t have been crazy to short 1% of the outstanding stock. That’s 740k shares. If you shorted in June and covered in September, you would have sold at around $22 and covered at about $13, for a profit of about $6.6m.

This kind of trade happens. It happens a lot. Investigative short-sellers have highlighted bad loans and money laundering, poor background checks at a babysitting platform, medical companies aggressively over-selling to the VA, even illegal logging.

Granted, they’re not always right. But there’s a wonderful property of financial markets: they tend to punish people for mistakes, so experienced people concede their errors. (In one of the cases I mentioned above, a major short-seller now owns the stock.)

Of course, we all know it’s crazy to short just because you’ve spotted a risk, especially if it’s a risk the company discloses.

So let’s assume this hedge fund analyst is a bit more aggressive than average, and pays for deep research into just how bad this industry is. MoJo disclosed the cost: about $350k. In MoJo’s model, you monetize by selling ads, and make five thousand dollars. In the hedge fund model, you monetize by buying puts, and make a couple zeroes more.

If you’re a fan of MoJo, imagine how much good they’d do if that prison article generated enough revenue for them to write another twenty.[1]

Of course, there are risks. What about litigation, for example? It’s one thing to sue a journalist for fibbing his way into a job to expose malfeasance, entirely another to sue a hedge fund for doing the same thing.

That is a risk, but less of one than it looks like: companies that fight short sellers tend to have extremely poor returns. If you get sued, be sure to call your lawyer — but only after you’ve told your trader to size up your short position.

What About the Class War?

I will go out on a limb and say, without strict quantitative evidence, that most investigative journalists are not deeply sympathetic to hedge fund managers’ desire to get paid millions and millions of dollars for generating above-market returns. Should investigative journalists feel motivated to work for hedge funds?

Maybe.

The way I’d look at it is that the financial industry is on average morally neutral: it’s a bearer of bad news much more often than it’s a cause of it. Yes, we cause bubbles, and yes, those have negative effects, but in general most of us are not in the bubble-inflating business, just in the business of dealing with a bubble’s implications.

Moreover, an activist short-selling campaign is a sort of Capital-on-Capital battery case: a rich guy at a hedge fund makes money, and a rich guy running a crooked company, plus everyone who invested in him and implicitly thought he’d get away with it, loses. Since every seller has a buyer, short-sellers increase the number of shares available — if 20% of a company’s stock is sold short, investors on the long side own 120%. So when a company is heavily-shorted, it’s also heavily bought, disproportionate to its own fundamental value. This means that short sellers increase the money-weighted population of bad guys who will get their comeuppance.

Policy Implications

Since all policies involve tradeoffs, I like to think cost-first: we should loosen reporting restrictions enough that more dodgy, fraudulent, or otherwise scummy companies go public. Yes, they will go to zero, and yes, people will get hurt. But if you take it as a given that these companies are behaving unethically, an IPO is a way to sharpen the contradiction between a company’s claims about what it does and its actual effect on society.

There are many people who are motivated by improving the world, but empirically a whole lot more of us are motivated by getting paid. We will get paid a little if we take down a shady competitor, but the benefits are diffuse — one less competitor benefits everyone in an industry, so your benefit is diluted to the extent that you have low market share. And if you have high market share, good luck knifing one of your competitors and getting away with it.

A publicly traded stock internalizes the positive externality of completely wrecking a company that deserves to get wrecked; the short seller collects a direct and immediate benefit, as long as they’re successful in showcasing how bad the company is.

Most people agree that investigative journalism is a valuable service. Most informed observers agree that the current business model of journalism doesn’t give us as much investigative journalism as we really need. The solution awaits: in a better world, we’ll have more crooks filing S-1s — and more investigative journalists showing up to work in Maseratis.

Thanks to Alexey Guzey for edits.

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[1] I am, as it happens, not a MoJo fan. I’m sure they are nice people, but in general the policies they advocate are bad, bad, bad. I’m only giving them this fabulous monetization advice thanks to my conviction that they will never in a million years take it.

In the case of this private prisons article, I’m not convinced the issue is with private prisons, so much as it’s an issue that prisons are awful and prison guard unions are effective lobbyists for harsher punishments. Since private prisons house about 8% of the prison population, they’d have to be at least 10x as bad per prisoner to be as big a problem as prisons overall.

Whichever prison guard union lobbyist came up with “private prisons” as the bogeyman, rather than incarceration generally, was a PR genius who belongs in the same pantheon as the Febreze team or whichever long-forgotten insurance person realized there was a happier-sounding name for Death Insurance.

I write about technology (more logos than techne) and economics. Newsletter: https://diff.substack.com/

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