1. Module 4 Social Determinants of Financial Reporting

2. Introduction
Traditionally, the only measure of firm performance was profit
However, public expectations have changed so that organisations are now required to address human, environmental and other social issues
Community perceptions can influence the disclosure policies of an organisation

3. Systems-oriented theories
Two systems-oriented theories-
Legitimacy theory
Stakeholder theory
Focus on the role of information and disclosure in the relationships between organisations, government, individuals and groups
The entity is influenced by, and influences the society in which it operates

4. Political Economy Theory
Legitimacy Theory and Stakeholder Theory are derived from Political Economy theory
Political economy ‘is the social, political and economic framework within which human life takes place’
Economic issues cannot be investigated in the absence of considering the political, social and institutional framework within which economic activity takes place

5. Political Economy Theory— continued
Corporate reports not considered neutral and unbiased, but are a product of the interchange between the corporation and its environment
Legitimacy Theory and Stakeholder Theory can be applied to help explain why an entity might elect to make particular voluntary disclosures

6. 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 upon the notion of a ‘social contract’

7. Legitimacy and legitimation
Legitimacy is the status or condition which exists when an entity’s value system is perceived as congruent with that of the society
legitimation is the process which leads to an organisation being viewed as legitimate. This ‘process’ can include corporate disclosures.

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

9. 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

10. 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

11. 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

12. Role of public disclosure
Public disclosure in such places as annual reports 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

13. Empirical tests of Legitimacy Theory
Used by 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

14. Conclusions from tests of Legitimacy Theory
Increase in disclosures following social incidents or environmental dissasters, and around proven environmental prosecutions
Increased disclosure over time associated with increased environmental group membership
Disclosures mostly positive

15. 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

16. 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
Why is it important to be legitimate?

17. Stakeholder Theory

18. 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 and Reed 1983)
Examples include shareholders, creditors, government, employees, employee’s families, local communities, and future generations

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

20. Ethical branch of Stakeholder Theory
Normative theory - what ‘should’ happen
All stakeholders have the right to be treated fairly by an organisation
Management should manage the organisation for the benefit of all stakeholders
Each group merits consideration in its own right and has right to be provided with information, even if not used
Issues of stakeholder power are not directly relevant

21. Right to information— accountability
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

22. 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
Expectations of stakeholders considered to impact on operating and disclosure policies

23. 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
eg. labour, finance, influential media, ability to legislate, ability to influence consumption of the organisation’s goods and services

24. Stakeholder power—continued
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

25. 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

26. Examples of empirical studies
Too early to draw overall conclusions from this area of research
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

27. 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

28. Legitimacy and Stakeholder Theories
Many similarities between Legitimacy Theory and Stakeholder Theory (managerial branch)
should not be treated as two separate theories but two (overlapping) perspectives of the issue set within a ‘political economy’ framework
Stakeholder theory specifically considers the different stakeholder groups within society, and how they could best be managed
not society as a whole like Legitimacy Theory

29. For Tutorials Required reading Self assessment questions
Text chapter 8
Self assessment questions
Questions from module 4
Answers in tutorials