Systems-oriented theories

• Legitimacy Theory, Stakeholder Theory and

Institutional Theory are all systems-based
theories
• Focus on the role of information and
disclosure in the relationships between
organisations, the State, individuals and
groups
• The entity is influenced by, and influences, the
society in which it operates

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 Political Economy Theory
• Legitimacy Theory, Stakeholder Theory and
Institutional Theory derived from Political
Economy theory
• Political economy is ‘the social, political and
economic framework within which human life
takes place’ (Gray, Owen & Adams 1996, p. 47)
• Economic issues cannot be investigated in the
absence of considering the political, social and
institutional framework within which economic
activity takes place

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 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

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 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

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 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
derive from this branch
• Does not question or study the various class
structures within society

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 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’

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 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

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 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

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 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
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 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

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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

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 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

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 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

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 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

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 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 information than
non-prosecuted firms

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 Examples of empirical studies (cont.)
• 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

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 Examples of empirical studies (cont.)
• 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

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 Examples of empirical studies (cont.)
• 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
• 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)
– a US study on the choice of an accounting framework
– related to a desire to increase the legitimacy of an
organisation

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 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)

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 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

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 Ethical 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

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 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

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 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)

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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
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 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

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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

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 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
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 Managerial branch of Stakeholder
Theory (cont.)
• Theories 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

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 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

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 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

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 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

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 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

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 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

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 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

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 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

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 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

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 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
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 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
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 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

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 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’

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 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

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 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

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