1. ACCT3003 Issues in Accounting Theory
Topic 6
Systems-oriented theories

2. 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

3. 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

4. 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

5. 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’

6. 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

7. 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

8. 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

9. 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

10. 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

11. 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

12. 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

13. 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

14. 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)

15. 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

16. 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

17. 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

18. 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

19. 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

20. 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

21. 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

22. 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

23. 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

24. 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

25. 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

26. 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

27. 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

28. 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

29. 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