Deegan fat4e ppt_ch08

8-1Copyright © 2014 McGraw-Hill Education (Australia) Pty Ltd PPTs to accompany Deegan, Financial Accounting Theory 4e

FINANCIAL ACCOUNTING THEORYCraig Deegan

Slides written by Craig Deegan

CHAPTER 8Unregulated corporate reporting decisions: considerations of systems-oriented theories


Learning objectives8.1 Understand how community or stakeholders’ perceptions

can influence the disclosure policies of an organisation and, conversely, how corporate disclosures can influence community and stakeholder perceptions.

8.2 Understand the fundamentals of Legitimacy Theory, Stakeholder Theory and Institutional Theory and appreciate that these theories have much in common with each other.

8.3 Understand that the above theories are, in large part, derived from Political Economy Theory, and that Political Economy Theory can be considered as having two branches.

8.4 Understand how Legitimacy Theory, Stakeholder Theory and Institutional Theory can be applied to help explain why an entity might elect to make particular voluntary disclosures.


Learning objectives (cont.)

8.5 Understand what we mean by ‘organisational legitimacy’ and how corporate disclosures within such places as annual reports and corporate websites can be used as a strategy to maintain or restore the legitimacy of an organisation.

8.6 Understand that the legitimacy attributed to an organisation can change across time and understand how corporate disclosures can be used as a means of establishing, maintaining or repairing legitimacy.

8.7 Understand how, pursuant to Stakeholder Theory, the respective power and information demands of particular stakeholder groups can influence corporate disclosure policies.

8.8 Understand that Stakeholder Theory can be considered as having an ethical branch and a managerial branch.


Learning objectives (cont.)8.9 Understand that corporate disclosure of information can be

used as a means of managing powerful stakeholder groups.

8.10 Understand the view that a successful organisation is one that is able to balance or manage the demands (sometimes conflicting), including information demands, of different stakeholder groups.

8.11 Understand that institutional pressures exist that cause organisations to take on organisational forms and practices that are considered ‘legitimate’.

8.12 Understand that due to institutional pressures there can be a ‘decoupling’ between the way an organisation appears to be operating and how it is actually operating.

8.13 Be aware of some of the limitations of the theories discussed in this chapter.


Systems-oriented theories

• Legitimacy Theory, Stakeholder Theory and Institutional Theory – the theories we discuss in this lecture – are all systems-based theories

• These theories focus on the role of information and disclosure in the relationships between organisations, the State, individuals and groups

• The entity is perceived as being influenced by, and influences, the society in which it operates


The organisation viewed as part of a broader social system


Political Economy Theory• Legitimacy Theory, Stakeholder Theory and Institutional

Theory are derived from Political Economy Theory

• The political economy is ‘the social, political and economic framework within which human life takes place’ (Gray, Owen & Adams 1996, p.47)

• The argument is that economic issues cannot be investigated in the absence of considering the political, social and institutional framework within which economic activity takes place – must all be considered within ‘context’

continued


Political Economy Theory (cont.)

• Corporate reports not considered neutral and unbiased, but are a product of the interchange between the corporation and its environment

• Two streams of Political Economy Theory

– classical

– bourgeois


Classical Political Economy Theory

• Related to the works of Marx

• Considers class interests, structural conflict, inequity and the role of the state

• Accounting reports and disclosures are a means of maintaining the favoured position of those who control scarce resources

• Focuses on the structural conflicts within society


Bourgeois Political Economy Theory

• Does not explicitly consider structural conflicts and class struggles

• Concerned with interactions between groups in an essentially pluralistic world

• Legitimacy Theory and Stakeholder Theory generally derive from this branch

• Does not question or study the various class structures within society


Legitimacy Theory• Legitimacy Theory is a widely used theory

• Within Legitimacy Theory, organisations seek to ensure they operate within the bounds and norms of their respective societies

– that is, they want their activities to be perceived as ‘legitimate’

• Bounds and norms are not static so require organisation to be responsive

• Legitimacy Theory (and Stakeholder Theory and Institutional Theory) can be used to help explain why an entity might elect to make particular voluntary disclosures

• Accounting disclosures are a strategy used by the firm to manipulate the firm’s relationships within the social system


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

• Legitimacy theorists often rely upon the notion that there is a ‘social contract’ between the organisation and the society in which it operates

continued


Legitimacy versus legitimisation (cont.)

• To be considered legitimate it is not the actual conduct of the organisation that is important, it is what society collectively knows or perceives about the organisation’s conduct that shapes perceived legitimacy

• Information disclosure is vital to establishing corporate legitimacy


Social contract

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

– legal requirements might provide the explicit terms of the contract, while other non-legislated societal expectations embody the implicit terms

• 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


Social contract (cont.)

As Mathews (1993, p.26) states:

The social contract would exist between corporations (usually limited companies) and individual members of society. Society (as a collection of individuals) provides corporations with their legal standing and attributes and the authority to own and use natural resources and to hire employees. Organisations draw on community resources and output both goods and services and waste products to the general environment. The organisation has no inherent rights to these benefits, and in order to allow their existence, society would expect the benefits to exceed the costs to society.


Implications of not meeting social contract

• Society allows the organisation to continue operations to the extent that it meets their expectations – which is often considered as being the same as being ‘legitimate’

• 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


Legitimacy and changing community expectations• Community expectations are not static

• As community expectations change, organisations must also adapt and change

• Legitimacy can be threatened even when the organisation’s performance is not deviating from society’s expectations

– perhaps the organisation has failed to make disclosures that show it is complying with community expectations

• Or, perhaps previously unknown information about the organisation comes to light (perhaps through the media)

– part of the ‘organisation shadow’ is revealed


Phases of legitimationThree broad phases are often identified by researchers, these being:

•gaining legitimacy phase

– ‘liability of newness’

– acceptance of community won through communication

•maintaining legitimacy phase

– need to anticipate changing community perceptions

– the more the organisation ‘trades’ on its legitimacy, the more important it is that the organisation protects it

•repairing (defending) lost legitimacy phase

– often a reactive process to unforseen crises

– much of the legitimacy theory-related research relates to this phase


Actions to legitimise activities

• Dowling and Pfeffer (1975) suggest the following strategies when legitimacy has been threatened:

– 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• Consistent with Dowling and Pfeffer’s strategies,

Lindblom (1993) suggests a number of strategies managers might adopt when legitimacy is threatened:

– 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

• Again, public disclosure of information is an important element of all of the above strategies


Abandonment of legitimising efforts

• There might come a time where legitimising efforts are deemed to be of limited use

• Consider Tilling and Tilt’s (2010) research of Rothmans Australia – a tobacco manufacturer

• There came a point where legitimising efforts were abandoned


Phases of the legitimation process


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 legitimation strategies

• This is a perspective adopted by many researchers of social responsibility reporting

• Highlights the strategic nature of financial statements and other related disclosures

• Disclosures might be substantive or symbolic

– substantive disclosures would reflect actual changes in corporate activities

– symbolic disclosures do not reflect ‘real’ change but are made to appear consistent with social values and expectations


Empirical tests of Legitimacy Theory

• Used by numerous researchers examining social and environmental reporting practices

• Used to attempt to explain disclosures, and often, to explain changing patterns of 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):

– examined the change in the extent of environmental disclosures of US oil firms around the Exxon Valdez oil spill in Alaska

– Legitimacy Theory suggested that they would increase disclosure in the annual report after the spill

– found the increase in disclosure occurred across the industry

continued


Examples of empirical studies (cont.)

• Deegan and Rankin (1996):

– used Legitimacy Theory to explain changes in annual report, environmental disclosure policies around proven environmental prosecutions

– prosecuted firms disclosed significantly more environmental information in the year of prosecution than any other year

– prosecuted firms disclosed more ‘positive’ environmental information than a matched sample of non-prosecuted firms

continued



• Deegan and Gordon (1996):

– investigated the objectivity of environmental disclosure practices and trends over time, as well as whether environmental disclosures related to environmental group concerns

– found increased disclosure over time associated with increased environmental group membership

– disclosures mostly positive

– positive relation between environmental sensitivity of industry and disclosure

continued



• Gray, Kouhy and Lavers (1995):

– performed longitudinal study of UK social and environmental disclosures from 1979 to 1991

– related trends to Legitimacy Theory, with specific reference to Lindblom’s strategies

• Deegan, Rankin and Voght (2000):

– used Legitimacy Theory to explain how social disclosures in annual reports changed around the time of major social incidents or disasters

continued



• Brown and Deegan (1998) emphasised the role of the media in shaping community expectations and showed that corporate disclosures responded to media attention

• Carpenter and Feroz (1992):

– undertook a US study on the government’s choice of an accounting framework

– related to a desire to increase the legitimacy of an organisation

continued


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


The difference between legitimation and accountability

• If a company makes disclosures because of concerns about its legitimacy then the disclosures are effectively being motivated by survival or profitability considerations rather than by a desire to demonstrate greater accountability

• There is much evidence to suggest that many corporate disclosures are a legitimation device and not an accountability mechanism


Issues not currently addressed by Legitimacy Theory

• Legitimacy Theory is a very widely used theory, particularly in the social and environmental accounting area.

• Because of its widespread use it is relevant to consider some of the ‘apparent gaps’ in the theory

• Gaps include:

– A lack of detail about how ‘legitimacy’ can be measured

This would be a subjective exercise. Perhaps consider the flow of resources to the organisation as a ‘proxy’ for legitimacy

continued


Issues not currently addressed by Legitimacy Theory (cont.)

– What disclosures are more effective in the legitimation process?

To date, relatively little insight has been provided into the type of disclosures that are most effective in establishing, maintaining, or repairing legitimacy. More theoretical development is necessary.

What medium of disclosure is most effective in legitimising the organisation?

Do different stakeholders react differently to different types of disclosures, or disclosures provided in different media?

Which social groups actually confer legitimacy?

• Assumes that disclosure strategies are driven by self interest

– a simplistic assumption

– certain actions become institutionalised rather than be driven by legitimation strategies

continued


Issues not currently addressed by Legitimacy Theory (cont.)

• Researchers who apply Legitimacy Theory typically do not consider actions that are aimed at legitimising the broader social system

– A predominant focus on organisational-level legitimacy. More attention should be given to efforts to legitimise broader social systems. According to Archel et al (2009):

...researchers should think more broadly about the legitimation strategies undertaken by organisations. Whilst disclosure strategies might be undertaken to inform, educate or even manipulate society in a manner intended to provide legitimacy to the organisation, researchers should also consider whether the disclosures might have a broader impact in terms of efforts to legitimise particular economic, social and political systems that potentially undermine the interests of particular stakeholders (such as employees).


Stakeholder Theory

• We will now turn our attention to Stakeholder Theory

• There are two broad branches of Stakeholder Theory, these being the:

– ethical (moral) or normative branch

– positive (managerial) branch

• There are 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

continued


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


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


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

continued


Managerial branch of Stakeholder Theory (cont.)• 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


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

continued


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 are 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) are responsive to the expectations of multinational buying companies, with the multinational buying companies in turn being responsive to the expectations of Western consumers (whose 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


Diagrammatic representation of differences between the ethical and managerial branches of Stakeholder Theory


Institutional Theory• The last theory we will consider in this lecture is Institutional

Theory.

• Institutional Theory provides an explanation about why organisations tend to take on similar characteristics, form and processes (including similar reporting practices)

• 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


Institutional Theory – the meaning of ‘institution’• According to Scott (2008):

– Institutions are comprised of regulative, normative and cultural-cognitive elements that, together with associated activities and resources, provide stability and meaning to social life.

• Meyer, Boli, and Thomas (1987, p. 13) provide a slightly different meaning of ‘institution’ but one which is consistent with the above definition:

– We see institutions as cultural rules giving collective meaning and value to particular entities and activities, integrating them into larger schemes.

continued


Institutional Theory (cont.)

• The theory links organisation practices to societal values

• Organisational form tends towards some form of homogeneity

– ‘deviants’ will have problems gaining or maintaining legitimacy

– Certain ways ‘of doing things’ are seen as legitimate – they become ‘institutionalised’

– Once process become institutionalised they effectively become ‘beyond the discretion of individuals and organisations’

continued


Institutional Theory (cont.)• Formal organisational structures and practices might be considered

by society as legitimate

• However, this does not necessarily mean they are the most efficient choice in terms of technical efficiency

• Organisations conform to institutionalised approaches (also referred to as ‘myths’ within the literature) by building gaps or ‘buffers’ between the formal structures which people see (the ‘myths’ that maintain legitimacy) and the actual work processes that create internal functional and technical efficiency (Meyer and Rowan, 1977)

• The formal structures and procedures of an organisation – which are the structures and procedures projected to others – reflect the rationalised institutional rules of the wider institutional environments in which organisations operate

• The status of an organisation’s legitimacy reflects the ‘social fit’ of the organisation within its environments


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

continued


Mimetic isomorphism (cont.)

• 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

• 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


Concluding comments• We can see that there is much overlap between the three theories

just discussed

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

• With Chapters 7 and 8 in mind we can see that we have a variety of different insights into why management might voluntarily elect to make particular disclosures or to embrace particular organisational forms

• However, it should also be appreciated that there are a number of other theories ‘out there’ that we have not discussed which also provide insights into what motivates managers to undertake particular activities, inclusive of reporting

• Researchers therefore have much choice when selecting amongst competing theories