ACCT3003 Issues in Accounting Theory Topic 6 Systems-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