ACCT3003 Issues in Accounting Theory

Topic 6Systems-oriented theories

Learning Objectives

how community or stakeholders’ perceptions can influence the disclosure policies of an organisation

Legitimacy Theory, Stakeholder Theory and Institutional Theory

help explain why an entity might elect to make particular voluntary disclosures

organisational legitimacy how corporate disclosures within annual

reports can be used as a strategy to maintain or restore the legitimacy of an organisation

Learning objectives (cont.)

how the respective power and information demands of particular stakeholder groups can influence corporate disclosure policies

the view that a successful organisation is one that is able to balance or manage the demands, including information demands, of different stakeholder groups

Systems-oriented theories

Legitimacy Theory, Stakeholder Theory and Institutional Theory are all systems-based theories derived from political economy theory

Focus on the role of information and disclosure in the relationships between organisations, the State, individuals and groups

Entities are influenced by, and influence, the society in which they operate

Legitimacy Theory

Organisations seek to ensure they operate within the bounds and norms of their respective societies activities are perceived to be ‘legitimate’

Bounds and norms not static so require organisation to be responsive

Relies on the notion of a ‘social contract’

Legitimacy versus legitimation

Legitimacy is the status or condition which exists when an entity’s value system is congruent with that of society

Legitimation is the process which leads to an organisation being viewed as legitimate

Social contract

Represents the implicit and explicit expectations that society has about how the organisation should conduct its operations

Traditionally the optimal measure of performance was profit maximisation

Public expectations have changed so organisations are now required to address human, environmental and other social issues

Implications of not meeting social contract

Society allows the organisation to continue operations to the extent that it meets their expectations

The organisation may find it difficult to obtain the necessary support and resources to continue operations may lead to sanctions such as legal

restrictions on operations, limited resources provided or reduced demand for products

Actions to legitimise activities

Adapt output, goals and methods of operation to conform to definitions of legitimacy

Attempt, through communication, to alter the definition of social legitimacy so it conforms with the organisation’s present practices, output and values

Attempt, through communication, to become identified with symbols or values which imply legitimacy

Communication to maintain legitimacy

Seek to educate and inform the community about changes in performance and activities

Seek to change perceptions but not behaviour

Seek to manipulate perception by deflecting attention from the issue to other related issues

Seek to change external expectations

Role of public disclosure

Public disclosure in such places as annual reports, sustainability reports and websites can be used to implement each of the previous strategies

Perspective adopted by many researchers of social responsibility reporting

Highlights the strategic nature of financial statements and other related disclosures

Empirical tests of Legitimacy Theory

Used by numerous researchers examining social and environmental reporting practices

Used to attempt to explain disclosures

Disclosures form part of the portfolio of strategies undertaken to bring legitimacy to or maintain legitimacy of the organisation

Examples of empirical studies

Patten (1992) Exxon Valdez oil spill in Alaska

Deegan and Rankin (1996) changes in annual report environmental

disclosure policies around proven environmental prosecutions

Deegan and Gordon (1996) whether environmental disclosures

related to environmental group concerns

How management determines society’s expectations

Legitimacy Theory proposes a relationship between corporate disclosure and community expectations

Management has been found to rely on the media, with the media being observed to shape community expectations (O’Donovan 1999)

Legitimacy Theory versus Positive Accounting Theory

Legitimacy Theory has been compared to the Political Cost Hypothesis of PAT

Legitimacy Theory relies on the notion of a ‘social contract’

It does not rely on the economics-based assumption that all action is driven by self-interest and wealth maximisation or make assumptions about the efficiency of markets

Stakeholder Theory

Two branches of Stakeholder Theory ethical (moral) or normative branch positive (managerial) branch

Many similarities between Legitimacy Theory and Stakeholder Theory should not be treated as two separate

theories but two (overlapping) perspectives of the issue set within a ‘political economy’ framework

Ethical branch of Stakeholder Theory

All stakeholders have the right to be treated fairly by an organisation

Management should manage the org. for the benefit of all stakeholders

Management have a fiduciary relationship to all stakeholders

Each group merits consideration in its own right

Also have a right to be provided with information, even if not used

Right to information—accountability

In considering rights to information accountability is considered

Accountability involves two responsibilities to undertake certain actions to provide an account of those actions

Reporting is assumed to be a responsibility rather than demand driven

Testing of ethical branch of theory

As involves normative perspectives about how the organisation should act, they cannot be validated by empirical observation

Normative theory attempts to interpret the function of, or provide guidance about, the corporation

Managerial branch of Stakeholder Theory

Attempts to explain when corporate management will be likely to attend to the expectations of particular (powerful) stakeholders

More organisation-centred stakeholders identified by the

organisation extent to which organisation believes

relationship needs to be managed in interests of the organisation

Managerial branch of Stakeholder Theory (cont.)

Theories can be tested with empirical observation

Specifically considers the different stakeholder groups within society, and how they should best be managed

Expectations of stakeholders considered to impact on operating and disclosure policies

Stakeholder power

Organisation will not respond to all stakeholders equally, but to the most powerful

Stakeholder power is a function of the stakeholder’s degree of control over resources required by the organisation e.g. labour, finance, influential media,

ability to legislate, ability to influence consumption of the organisation’s goods and services

Stakeholder power (cont.)

Major role of management is to assess the importance of meeting stakeholder demands so as to achieve strategic firm objectives

Expectations and power relativities of various stakeholders change over time

Organisation must continually adapt operating and disclosure strategies

The role of information

Information, including financial accounting and social performance information, is a major element employed to manage stakeholders

used to gain support or approval also used to distract their opposition

or disapproval

Examples of empirical studies

Roberts (1992) found measures of stakeholder power and

their related information needs can provide some explanation of levels and types of corporate social disclosures

Neu, Warsame and Pedwell (1998) firms more responsive (in terms of

corporate environmental disclosure) to the concerns of financial stakeholders and government regulators than to environmentalists

Ethical view versus managerial view

Management might either be ethically aware, or focused on the survival of the organisation

Management will arguably be driven by both ethical and performance considerations

We need to understand the complementary roles normative and descriptive research play

Institutional Theory

Provides an explanation about why organisations tend to take on similar characteristics and form

Particular organisational forms might be adopted in order to bring legitimacy to the organisation

Provides a complimentary perspective to both legitimacy theory and stakeholder theory

Institutional Theory (cont.)

Links organisation practices to societal values

Organisational form tends towards some form of homogeneity ‘deviants’ will have problems gaining or

maintaining legitimacy

Concluding comments

We can see that there is much overlap between the three theories just discussed

Sometime a joint consideration of different theoretical perspectives can provide a more holistic understanding of particular practices