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Unformatted text preview: ACCT3003 Issues in Accounting Theory 2009 Topic 7: Systems based theories Solutions to topic review questions 8.1 A ‘social contract’ is a theoretical contract between one party, perhaps a company, and society. It is not written, but is implied. The social contract (or as it is sometimes called, the community license to operate) incorporates community norms and expectations about how an organisation should conduct its operations (including what information it produces). As community norms and expectations are expected to change across time, the ‘terms’ of the social contract are also expected to change across time. Different people will have different perceptions about what the terms of the social contract are, and hence, they will have different expectations about how an organisation should operate and the extent of accountability that is due. One can certainly not say with any precision what the terms of the contract are at a particular point in time. In linking the notion of a social contract with the concept of organisational legitimacy, it is argued that for an organisation to be legitimate it must conform to the expectations of the community in which it operates. According to Lindblom (1994) an organisation is legitimate when its value system is perceived as being congruent with the value system of the larger social system of which the entity is a part. To be legitimate the organisation must conform to the terms of the social contract. Failure to comply with these terms will bring the legitimacy of the organisation into doubt and this in turn is expected to have implications for the ongoing survival of the organisation. As the chapter indicates, Shocker and Sethi (1974, p. 67) provide a good overview of the concept of a social contract. They state: Any social institution—and business is no exception—operates in society via a social contract, expressed or implied, whereby its survival and growth are based on: (1) the delivery of some socially desirable ends to society in general, and (2) the distribution of economic, social or political benefits to groups from which it derives its power. Issues in Accounting Theory 2009 Solutions: Topic 7 1 In a dynamic society, neither the sources of institutional power nor the needs for its services are permanent. Therefore, an institution must constantly meet the twin tests of legitimacy and relevance by demonstrating that society requires its services and that the groups benefiting from its rewards have society’s approval. As an additional issue, students should consider how management might actually be able to determine the terms of the social contract. Pursuant to the notion of organisational legitimacy there is a view that organisations must be seen or perceived to be operating in compliance with community norms and expectations. That is, they must be believed to be operating in compliance with the social contract. Accepting this theoretical perspective, it is not just important that management actually be doing the ‘right’ things, there must be a perception by the community that they are doing the right things. Hence, it is important that the organisation tells the community about what it is doing and one way of doing this is by various corporate disclosures through such media as the annual report. As the chapter indicates, the disclosure of information is deemed by Dowling and Pfeffer (1975) and Lindblom (1994) to be an important course of action to maintain, or reinstate, legitimacy. Determining the terms of the social contract, that is, what the norms and expectations of the community are, is clearly not an easy exercise. Different managers will have different perceptions about what is expected. It could be argued that a successful manager is one who is best able to understand community expectations, and to respond to changes therein. The social contract can be construed as being made up of some ‘clauses’ that are explicit, and some that are implicit. Explicit clauses may be ‘easier’ to determine. Gray, Owen and Adams (1996) suggest that legal requirements provide the explicit terms of the contract, while other non‐legislated societal expectations embody the implicit terms of the contract. That is, there is an imperfect correlation between the law and societal norms (as reflected by the social contract) and according to Dowling & Pfeffer (1975), there are three broad reasons for the difference. Firstly, even though laws are reflective of societal norms and values, legal systems are slow to adapt to changes in the norms and values in society. Secondly, legal systems often strive for consistency whereas societal norms and expectation can be contradictory. Thirdly, it is suggested that while society may not be accepting of certain behaviours, it may not be willing or structured enough to have Issues in Accounting Theory 2009 Solutions: Topic 7 2 8.4 8.5 those behavioural restrictions codified within law. It is in relation to the composition of the implicit terms of the ‘contract’ that we can expect managers’ perceptions to vary greatly. Various approaches have been suggested as a means of understanding community expectations (which relate particularly to the implicit terms of the social contract), and these include the following: (a) Reviewing various community‐based surveys that have been undertaken to establish community views on particular issues. In most countries, various government departments, as well as a number of private sector ‘polling’ organisations, undertake different attitudinal surveys from time to time. (b) Many organisations subscribe to services that scan the news media and which identify the issues that are attracting the most coverage. Such an approach adopts a perspective that the news media reflects, or perhaps shapes, public perceptions 9pasrticular, perhaps, in relation to unobtrusive issues). (c) Some managers directly engage their stakeholders through various stakeholder meetings. Within these meetings the managers ask representatives of groups such as local community, environmental, employee, investment and consumer groups about what expectations they have about the organisation and whether the organisation is seen to be operating in a manner consistent with their expectations. There is no universally accepted way of learning about the community’s expectations. While a minority of management teams might appear to ignore community expectations (they do not see themselves as part of a broader social system) it is generally accepted that more and more organisations are undertaking greater dialogue with various stakeholder groups. Failure to consider community expectations and changes therein are expected to lead to negative implications for an organisation with an extreme result being that the organisation will be driven out of business. Organisations are not considered to have any absolute right to exist. 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 Issues in Accounting Theory 2009 Solutions: Topic 7 3 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. Pursuant to Legitimacy Theory, if an organisation does not comply with community expectations, then in a sense the community may revoke its ‘contract’ to continue its operations. This may occur through consumers reducing or eliminating the demand for the products of the business, factor suppliers eliminating the supply of labour and financial capital to the business, or constituents lobbying government for increased taxes, fines or laws to prohibit those actions which do not conform to the expectations of the community. On the basis of evidence provided by studies such as Patten (1992), Deegan and Rankin (1996) and Deegan, Rankin and Voght (2000), which are all referenced in the chapter, evidence does suggest that when an organisation has been involved in a major accident or event (such as loss of oil at sea, or a mine‐collapse) then the annual report will be used as a means to bolster the damaged image of the organisation involved. Consistent with the strategies suggested by Lindblom (1994) and Dowling and Pfeffer (1975), the annual report disclosures may be used to distract attention from the event itself and to highlight positive aspects of the organisation’s performance (for example, if the organisation has received publicity for breaching particular environmental laws, then it might use the annual report to talk about particular environmental awards that it has received). Alternatively, the annual report might be used as a means of down‐playing the significance of the event, or as a means of providing information to suggest that such an event will not occur again (perhaps because additional mechanisms have since been put in place). What the various evidence shows is that disclosure, in media such as the annual report, is a strategy that many organisations use when their legitimacy, and hence their livelihood, is threatened. Of course, other disclosure strategies could also be implemented at the same time. The term ‘legitimacy gap’ is a term that has been utilised by many researchers to describe the situation where there appears to be a lack of correspondence between how society believes an organisation should act and how it is perceived that the organisation has acted. In relation to how 4 8.7 8.8 Issues in Accounting Theory 2009 Solutions: Topic 7 legitimacy gaps arise, Sethi (1978) describes two major sources of the gaps. Firstly, societal expectations might change, and this will lead to a gap arising even though the organisation is operating in the same manner as it always had. The second major source of a legitimacy gap, according to Sethi (1977), occurs when previously unknown information becomes known about the organisation—perhaps through disclosure being made within the news media. Within the chapter, O’Donovan provides a diagrammatic representation of the legitimacy gap (see page 330). 8.10 Consistent with Legitimacy Theory, the successful operation of an organisation is dependent upon community expectations and perceptions. Hence, if we adopt this perspective then management would only react to particular events (such as an oil spill, lay‐off of workers) if they perceived that the community was concerned about the action or event—that is, they will respond if the believe the action or event was not in accordance with the ‘social contract’ negotiated between the organisation and the community. If management considers that their actions are consistent with the terms of the ‘contract’ then no remedial or legitimating action would be necessary. (If a broader notion of accountability was adopted such a position would not be adopted. Disclosures would be made because of a responsibility to do so—not because legitimacy was threatened.) 8.11 In accordance with Gray, Owen and Adams (1996, p. 45): … a systems‐oriented view of the organisation and society … permits us to focus on the role of information and disclosure in the relationship(s) between organisations, the State, individuals and groups. Systems‐oriented theories have also been referred to as ‘open‐systems’ theories. Commenting on the use of open‐systems theorising, Suchman (1995, p. 571) states: Open‐system theories have reconceptualised organisational boundaries as porous and problematic … Many dynamics in the organisational environment stem not from technological or material imperatives, but rather, from cultural norms, symbols, beliefs and rituals. Corporate disclosure policies are considered to represent one important means by which management can influence external perceptions about their organisation. Within a systems‐based perspective, the entity is assumed to be influenced by, and in turn to have influence upon, the society in which it operates. Issues in Accounting Theory 2009 Solutions: Topic 7 5 8.12 The ethical (sometimes referred to as normative or moral) branch of stakeholder theory is concerned with prescribing how management should act with regards to its various stakeholder groups. Stakeholders themselves have been broadly defined by Freeman and Reed (1983, p. 91) as: 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. The ethical branch of stakeholder theory is very much concerned with the responsibilities of an organisation and does not consider that people’s rights should be influenced by issues such as how powerful they are. Typically, work in this branch of stakeholder theory will argue that all stakeholders should benefit from the existence of an organisation and the rights and interests of one class (for example, shareholders) should not dominate the rights or interests of others. There are certain key rights (for example, safe working conditions) that should never be violated. Accepting the perspective that all stakeholders have certain minimum rights that must not be violated, we can acknowledge that this perspective can be extended to a notion that all stakeholders also have a right to be provided with information about how the organisation is impacting them (perhaps through pollution, community sponsorship, provision of employment, safety initiatives etc.), even if they choose not to use the information, and even if they cannot directly impact the survival of the organisation. Because the ethical branch of stakeholder theory provides prescription about how management should act, the theory cannot be validated or invalidated by empirical investigation. That is, the theory does not set out to predict how managers will behave (which can be empirically tested). Rather, it prescribes how they should behave. 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. The managerial branch of stakeholder theory, by contrast, suggests or predicts that managers will attempt to manage the relationship with various stakeholders to ensure that the interests or goals of the organisation are best achieved. The more important the stakeholder is to the organisation Issues in Accounting Theory 2009 Solutions: Topic 7 6 achieving its goals, the more effort will be spent in managing the relationship. The disclosure of information is considered to represent an important strategy in managing the relationship. Not all stakeholder groups will be treated equally and some ‘rights’ might be ignored if they are not important to the organisation’s operations. The managerial branch of stakeholder theory asserts that the power of stakeholders to influence management will be related to the stakeholders’ control over resources needed by the organisation. As Ullman (1985, p. 2) states: … organisations survive to the extent that they are effective. Their effectiveness derives from the management of demands, particularly the demands of interest groups upon which the organisation depends. The disclosure of information is considered to represent one of the strategies to manage powerful stakeholder groups. 8.14 (a) Applying the managerial perspective of stakeholder theory, the managers of banks would only care about the concerns of One Parent Families to the extent that, as a group, these stakeholders have the power to influence the goals of the organisation (which may, or may not, be fixated on corporate profitability). If they do not have such power then the theory would suggest that their concerns would be given minimal priority. The managerial branch of stakeholder theory does not consider the broader issues of banks’ responsibilities to various groups. As single parent families would be a stakeholder of the banks (they have their deposits with the banks and the banks’ fee structures will impact their wealth) then the ethical (or normative, or moral) branch of stakeholder theory would argue that a responsibility is owed to them, regardless of their inability to influence the profitability of the banks. Under this perspective, a responsibility is owed to all parties that are affected by the banks’ operations, and hence the bank should care about the harm potentially being caused to one‐parent families. If society considered that the banks were being unreasonable then the legitimacy of the banks would be brought into question. Consistent with Legitimacy Theory, and a number of the studies referred to in this chapter, we would expect banks to use annual report disclosures as a 7 (b) (c) Issues in Accounting Theory 2009 Solutions: Topic 7 strategy to minimise the damage to reputation (and profitability) that might follow publicity such as that provided in Accounting Headline 8.6—but only to the extent that the legitimacy of the organisation was threatened in a way that negatively impacted its operations. It would be an interesting exercise for students to gather the annual reports of a number of banks and see the types of social disclosures they are making. Do the disclosures appear to be of a legitimating character? 8.15 There is a good deal of research from a theoretical perspective called Media Agenda Setting Theory which indicates that the media not only reflects community concerns, but it can also set or create community concerns. If the media makes a number of negative comments about an organisation then this in turn will possibly change the public’s opinion about the organisation and could possibly bring the legitimacy of the organisation into question. This could explain why some organisations pay high‐profile media personalities large sums of money to ensure that they have the personalities’ support. Consistent with Legitimacy Theory, if an organisation considers that its legitimacy is threatened (perhaps as a result of the negative media attention) then it will undertake various strategies to gain legitimacy. One strategy would be to make various disclosures within such media as the annual report, or on the organisation’s website, and these disclosures could attempt to downplay the concerns or, alternatively, the disclosures may represent an attempt to shift attention to other, more favourable, aspects of the organisation’s operations. 8.23 Consistent with legitimacy theory the supermarkets would only react if they thought the report was likely to create legitimacy threats for them. That is, whether they react would dependent upon the supermarkets’ perceptions of whether the concerns expressed within the article where likely to become widespread across the community. Given that the article appeared within Pharmacy News it is probably unlikely to attract a great deal of readership. Further, most people would already be aware that supermarkets sell cigarettes (they are quite visible) hence the article is not addressing something that is otherwise unobtrusive, or in the ‘corporate shadow’. Hence it would be unlikely that the supermarkets would feel threatened. However, if they did feel threatened then legitimacy theory would suggest that they might either take actions to address the concerns of the pharmacists, and disclose information about their actions, or alternatively, perhaps use corporate disclosures to demonstrate why the issues raised by the Issues in Accounting Theory 2009 Solutions: Topic 7 8 pharmacists are unfair (and they would not actually change their corporate policies). From a stakeholder theory perspective (managerial branch), the supermarkets would only respond to the pharmacists if they considered that they were ‘powerful, that is, able to impact the operations of the supermarkets. This would be a matter of judgement, but in the absence of any apparent power then it would be unlikely the supermarkets would be particular worried by this group of stakeholders. Issues in Accounting Theory 2009 Solutions: Topic 7 9 ...
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This note was uploaded on 04/30/2011 for the course ACCT 3003 taught by Professor Jennymarks during the Three '10 term at South Australia.

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