CORPORATE REPORTING REGULATION AND CORPORATE SCANDALS Topic Lecture-16 CORPORATE REPORTING REGULATION AND CORPORATE SCANDALS 8 Readings Reference : Text chapter 8: Unregulated Corporate Reporting Decisions; Financial Accounting Theory; McGraw-Hill; 2nd Edition; 2006; pp 267-299.

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 to provide an insight into community perceptions, with the media being observed to shape community expectations (O’Donovan 1999) O’Donovan (1999) provided evidence that corporate managers believe that: the media shapes public concerns annual report disclosures are a means of winning back the support of the community after adverse media coverage

Impact of media attention Islam and Deegan (2008) reviewed the social and environmental disclosure practices of Nike and Hennes & Mauritz from 1987 to 2005 found a direct relationship between the extent of global news media coverage of a critical nature directed towards particular social issues and the extent of social disclosure in the annual report Their findings supported a view that: the media is able to influence community concerns in relation to unobtrusive issues (creates a legitimacy gap) managers will make disclosure responses to the media attention

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

Ethical (normative) branch of 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 (normative) branch of Stakeholder Theory All stakeholders have the right to be treated fairly by an organisation Issues of stakeholder power are not directly relevant Management should manage the organisation for the benefit of all stakeholders Firm is a vehicle for coordinating stakeholder interests Management have a fiduciary relationship to all stakeholders

Ethical branch of Stakeholder Theory (cont.) Where interests conflict, business managed to attain optimal balance among them Each group merits consideration in its own right Also have a right to be provided with information, even if not used This perspective of corporate responsibilities is not validated (or rejected) on the basis of empirical observations (that is, these researchers are providing argument about what should be and not what is)

Definition of stakeholders Any identifiable group or individual who can affect the achievement of an organisation’s objectives, or is affected by the achievement of an organisation’s objectives (Freeman & Reed 1983) There are two branches to the above definition Proponents of the ethical branch of stakeholder theory would include both branches when identifying stakeholders Proponents of a managerial perspective of stakeholder theory would only consider the first branch (that is, those stakeholder who can affect the achievement of the firm’s objectives)

Primary versus secondary stakeholders Primary stakeholders ones without whose continuing participation the corporation cannot survive as a going concern Secondary stakeholders those who influence or affect, or are influenced or affected by, the corporation, but they are not engaged in transactions with the corporation and are not essential for its survival Ethical branch does not differentiate between primary and secondary stakeholders In considering rights to information accountability is considered the duty to provide an account or reckoning of those actions for which one is held responsible 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 the ethical branch embraces normative perspectives about how the organisation should act, it cannot be validated by empirical observation As Donaldson and Preston (1995, p.67) state: In normative uses, the correspondence between the theory and the observed facts of corporate life is not a significant issue, nor is the association between stakeholder management and conventional performance measures a critical test. Instead a normative theory attempts to interpret the function of, and offer guidance about, the investor-owned corporation on the basis of some underlying moral or philosophical principles.

Managerial branch of Stakeholder Theory By contrast, this 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 Research undertaken under the managerial branch of stakeholder theory can be tested with empirical observation unlike normative ethical branch Specifically considers the different stakeholder groups within society, and how they should best be managed not society as a whole like Legitimacy Theory Expectations of stakeholders considered to impact on operating and disclosure policies

The role of information 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 Major role of management is to assess the importance of meeting stakeholder demands so as to achieve strategic firm objective 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 Islam and Deegan (2008) Garment suppliers in a developing country (Bangladesh) responsive to the expectations of multinational buying companies, with the multinational buying companies in turn being responsive to the expectations of western consumers (who’s expectations about working conditions, child labour, and so on – which are unobtrusive events - are influenced by the western media)

Ethical view versus managerial view By separately considering the two perspectives of Stakeholder theory, it could be construed that 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 ‘Organisations conform because they are rewarded for doing so through increased legitimacy, resources and survival capabilities’ (Scott 1987, p.498) Provides a complimentary perspective to both legitimacy theory and stakeholder theory Links organisation practices to societal values Organisational form tends towards some form of homogeneity ‘deviants’ will have problems gaining or maintaining legitimacy

Isomorphism and decoupling Two main dimensions of Institutional Theory are isomorphism and decoupling Isomorphism refers to ‘a constraining process that forces one unit in a population to resemble other units that face the same set of environmental conditions’ (DiMaggio & Powell 1983, p.149) Three different isomorphic processes coercive mimetic normative

Coercive isomorphism Arises where organisations change their institutional practices because of pressure from those stakeholders upon which the organisation is dependent Related to the managerial branch of stakeholder theory Because powerful stakeholders might have similar expectations of other organisations, there will tend to be conformity in practices across organisations, including their reporting practices Consider how the World Bank has been able to influence reporting practices in developing countries (Neu and Ocampo 2007)

Mimetic isomorphism Organisations often copy other organisation’s practices for competitive advantage and to reduce uncertainty ‘Uncertainty is a powerful force that encourages imitation’ (DiMaggio & Powell 1983, p.151) Organisations within a particular sector adopt similar practices to those adopted by leading organisations—enhances external stakeholders’ perceptions of the legitimacy of the organisation Without coercive pressure from stakeholders, it would be unlikely that there would be pressure to mimic others—hence linkage between mimetic and coercive isomorphism

Normative isomorphism Pressures from ‘group norms’ to adopt particular institutional practices Particular groups with particular training will tend to adopt similar practices—non-compliance could result in sanctions being imposed by ‘the group’ Again, provides a rationale for why reporting approaches, and other corporate processes, tend to take on similar form Outcomes of isomorphism Tendency towards similar corporate structures and processes Isomorphic processes do not necessarily make the organisations more efficient In practice it is not easy to differentiate between the three types of isomorphism Strategies might be more about ‘show’ or ‘form’, rather than about substance

Decoupling End of topic-8 Thanks for kind participation For example The practice is not integrated into the organisation’s managerial and organisational process. Although managers might see a need to be seen to be adopting particular structures and practices, actual organisational practices can be very different from the formally sanctioned and publicly pronounced processes and practices For example The organisational image constructed through corporate reports and other disclosures might be one of social and environmental responsibility when the actual managerial imperative is maximisation of profit or shareholder value End of topic-8 Thanks for kind participation