ACT301- Week 8 Tutorial

Chapter 9: Extending corporate accountability: the incorporation

of social and environmental factors within external reporting

9.2 We can refer to the definition of accountability provided by Gray, Owen and
Adams (1996, p.38), this being:

The duty to provide an account (by no means necessarily a financial

account) or reckoning of those actions for which one is held responsible.

According to Gray, Owen and Adams, accountability involves two

responsibilities or duties, these being:
(a) the responsibility to undertake certain actions (or to refrain from
taking actions); and
(b) the responsibility to provide an account of those actions.

In relating accountability to accounting we need to consider what we actually

mean by ‘accounting’. There is no definitive definition of accounting but
perhaps we can describe accounting as the process of providing information to
various stakeholders to allow those stakeholders to assess various aspects of the
entity’s performance and position for the purposes of making various decisions
about the entity (inclusive of whether they will support the entity through
providing labour, investment capital, consuming the entity’s products, and so
on). Traditionally, accounting has been considered to be a process of providing
information about financial performance and position to parties that have a direct
financial interest in the organisation—but this is an extremely restricted
perspective of accounting. (As an example of this myopic perspective, for a
number of years in the early to mid-1990s the author of your textbook was often
asked ‘what has the environment got to do with accounting?’. Thankfully, many
more people can now understand the relationship). In a sense, accounting
provides the mechanism through which accountability can be performed or
exercised. Since different managers will have different perspectives about what
is expected of them from their various stakeholders, different entities will
develop different accounting systems (for example, some organisations develop

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 systems that can generate social and environmental performance reports, while
others do not).

In considering the relationship between accountability and organisational

responsibilities, we can say that the two are directly linked. An organisation has
a responsibility to provide an account (that is, it has an accountability) of its
activities to enable others to determine whether the entity has been acting in the
manner in which it is expected to act. Gray, Owen and Adams (1996) developed
an ‘accountability model’ to explain the relationship. They consider that
accounting and the act of reporting is responsibility driven, rather than demand
driven. The view is that people have a right to be informed about certain facets
of an organisation’s operations. By considering rights, it is argued that the model
avoids the problem of considering users’ needs and how such needs are
established. The role of corporate reporting under this perspective is to inform
society about the extent to which actions for which an organisation is considered
responsible have been fulfilled.

9.4 This can actually be quite a controversial issue. The term ‘sustainable
development’ is used in many different ways by different organisations. For
example, some managers discuss how they seek to be sustainable at the same
time that they pursue increasing profits. Many people would argue that pushes
for increased profits do not sit well with visions of maintaining a sound
environment – also raising issues such as how much profit is enough.

From a theoretical perspective a sustainable organisation is one that leaves the

environment no worse than it was at the beginning of the period and considers
the interests of the communities in which it operates such that it does not
advantage some people at the expense of others. Sustainability also necessitates
consideration of future generations such that the current activities of the
organisation should not adversely impact people of the future.

The most widely used definition of sustainable development is the definition

provided in the Brundtland Report this being, development that meets the needs
of the present world without compromising the ability of future generations to
meet their own needs.

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 The notion of sustainable development, and the view that we must consider
future generations, necessarily requires us to give some consideration to
reducing our current (unsustainable) consumption patterns. Wealth creation
should not be the all-consuming motivation of modern business if sustainability
is a ‘real’ goal. Sustainable development necessarily requires reduced reliance
on performance indicators, such as profitability. This requires thinking other
than in self-interest. As we have seen throughout the text, central to many
economic theories is the assumption that individual action is driven by
consideration of one’s self, rather than consideration of others. If we are to
believe that self-interest drives all actions (as the positive accounting theorists
assume) then we would be resigned to a view that sustainable development is
nothing other than a fanciful dream.

9.9 Externalities can be defined as impacts that an entity has on parties (not
necessarily restricted to humans) external to the organisation, parties which
typically have no direct relationship with the organisation. Financial accounting
practices can tend to ignore externalities because of the way the elements of
financial accounting are defined and because accounting adopts an entity
assumption.

In relation to the entity assumption adopted within financial accounting, this

assumption requires the organisation to be treated as an entity distinct from its
owners, other organisations and other stakeholders. The implication is, if a
transaction or event does not directly impact on an entity, the transaction or
event is to be ignored for accounting purposes. This means that the externalities
caused by reporting entities will typically be ignored, thereby meaning that
performance measures are incomplete from a broader societal perspective.

In relation to the definition of the elements of accounting, definitions of assets

and expenses as provided in various conceptual framework projects throughout
the world (and as developed by the IASB) rely upon a notion of control. For
example, in the IASB Conceptual Framework assets are considered to be
resources ‘controlled by the entity as a result of past events and from which
future economic benefits are expected to flow to the entity’. If something is not
controlled, such as the waterways, the air, the local national parks, then it is not

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 considered to be an asset. As such, any reduction in the quality of the ‘public’
resource will not be considered an expense of an entity (unless there are some
associated cash flows, for example, environmental fines). Also, local
communities are not ‘assets’ of an entity from a financial accounting perspective
and hence any health problems caused to them by the entity’s operations will
typically be ignored (unless, again, some legal action has been instigated). Such
externalities caused by the reporting entity will be ignored.

As indicated in Deegan (1996), and using a rather extreme example, under

traditional financial accounting if an entity was to destroy the quality of water in
its local environment, thereby killing all local sea creatures and coastal vegetation
then to the extent that no fines or other related cash flows were incurred, reported
profits would not be directly impacted. No externalities would be recognised and
the reported assets/profits of the organisation would not be affected.

9.28 (a) Positive accounting theory predicts that all individual action is
‘economically rational’—that is, the decision to undertake certain
activities, such as report, is based on self-interest tied to the goal of
wealth maximisation. Hence, managers will elect to provide social
responsibility disclosures to the extent that it increases the value of the
organisation. Managers would be motivated to do this as a result of
various mechanisms that align the interests of the manager with
increasing firm value, such as profit-sharing bonus schemes, holding
shares in the firm, the market for managers, and the market for corporate
takeovers (these mechanisms are discussed in chapter 7). Research which
has adopted the PAT paradigm has suggested that social responsibility
disclosures are made to reduce the political visibility that the firm is
subject to and hence, to reduce the wealth transfers that are associated
with political scrutiny.

(b) Legitimacy theory predicts that firms will undertake various actions to
ensure that they appear to be operating in a manner consistent with the
norms and expectations of the community in which they conduct their
operations. That is, that they appear to comply with the terms of the
‘social contract’ (the theoretical notion of a social contract is discussed in

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 chapter 8). Hence, various social responsibility disclosures will be made
in an effort to legitimise the ongoing existence of the organisation. If it is
considered that the community does not expect the firm to make social
and environmental disclosures (that is, it is not part of the social
contract), then no disclosures will be made. As the chapter indicates,
where the legitimacy of an organisation has been brought into question
(perhaps as the result of a major environmental accident or event),
corporate management often use media such as the annual report in an
effort to restore legitimacy.

(c) As chapter 8 explains, there are two branches of stakeholder theory—the

managerial branch and the ethical (or normative, or moral) branch. Under
the managerial branch, disclosures are used as one strategy to control the
actions of powerful stakeholders. Powerful stakeholders are often
considered as those parties who have resources which are important to
the ongoing survival of the organisation. Under this perspective, it is the
needs of the powerful stakeholders that are attended to over and above
the needs of other parties affected by the entity’s operations. If the
powerful stakeholders expect social responsibility disclosures then the
firm is predicted to make them. By contrast, under the ethical, or
normative, branch of stakeholder theory there is a view that disclosures
are responsibility driven and that all stakeholders that are impacted by the
operations of the entity have a right to information about its operations
(the notion of right-to-know). Hence, under this perspective, social
responsibility disclosures are made in response to an ethical
responsibility, rather than in response to any desire to maximise wealth
or to appease particular, powerful parties.

(d) As chapter 8 indicates, institutional theory provides a number of reasons

why corporations might make corporate social responsibility disclosures.
There is a view that organisational form and practices might tend towards
some form of homogeneity—that is, the structure of the organisation and
the practices adopted by different organisations tend to become similar to
conform with what is considered to be ‘normal’. Organisations that
deviate from being of a form that has become ‘normal’ or expected will

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potentially have problems in gaining or retaining legitimacy. There are
two main dimensions to institutional theory. The first of these is termed
isomorphism while the second is termed decoupling. Both of these can be
of central relevance to explaining voluntary corporate reporting practices.

The term ‘isomorphism’ is used extensively within institutional theory

and DiMaggio and Powell (1983, p.149) have defined it as ‘a
constraining process that forces one unit in a population to resemble
other units that face the same set of environmental conditions’. That is,
organisations that adopt structures or processes (such as reporting
processes), that are at variance with other organisations, might find that
the differences attract criticism. DiMaggio and Powell (1983) set out
three different isomorphic processes. These three isomorphic processes
are referred to as coercive isomorphism, mimetic isomorphism and
normative isomorphism.

Pursuant to coercive isomorphism, organisations will only change their

institutional practices because of pressure from those stakeholders upon
whom the organisation is dependant. This form of isomorphism is related
to the managerial branch of stakeholder theory whereby a company will
use ‘voluntary’ corporate reporting disclosures to address the economic,
social, environmental and ethical values and concerns of those
stakeholders who have the most power over the company. The company
is therefore coerced (in this case usually informally) by its influential (or
powerful) stakeholders into adopting particular voluntary reporting
practices. Since these powerful stakeholders might have similar
expectations of other organisations as well, there will tend to be
conformity in the practices being adopted by different organisations—
institutional practices will tend towards some form of uniformity.

Mimetic isomorphism involves organisations seeking to emulate (perhaps

copy) or improve upon the institutional practices of other organisations,
often for reasons of competitive advantage and in terms of legitimacy.
When an organisation encounters uncertainty then it might elect to model
itself on other organisations. There are links between the pressures for

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mimetic isomorphism and pressures underlying coercive isomorphism.
Unerman and Bennett (2004) maintain that without coercive pressure from
stakeholders there would be unlikely to be pressure to mimic or surpass the
social reporting practices (institutional practices) of other companies.

Normative isomorphism relates to the pressures arising from group norms

to adopt particular institutional practices. In the case of corporate
reporting, the professional expectation that accountants will comply with
accounting standards acts as a form of normative isomorphism for the
organisations for whom accountants work to produce accounting reports
(an institutional practice) which are shaped by accounting standards. In
terms of voluntary reporting practices, normative isomorphic pressures
could arise through less formal group influences from a range of both
formal and informal groups to which managers belong—such as the
culture and working practices developed within their workplace. These
could produce collective managerial views in favour of or against certain
types of reporting practices (such as collective managerial views on the
desirability or necessity of providing a range of stakeholders with social
and environmental information through the medium of corporate reports).

Turning to the other dimension of institutional theory, decoupling implies

that while managers might perceive a need for their organisation to be
seen to be adopting certain institutional practices (and might even
institute formal processes aimed at implementing these practices) actual
organisational practices can be very different to these formally
sanctioned and publicly pronounced processes and practices. Thus, the
actual practices can be decoupled from the institutionalised (apparent)
practices. In terms of voluntary corporate reporting practices, this
decoupling can be linked to some of the insights from legitimacy theory
whereby social and environmental disclosures can be used to construct an
organisational image very different from actual organisational social and
environmental performance. Thus, the organisational image constructed
through corporate reports might be one of social and environmental
responsibility when the actual managerial imperative is maximisation of
profitability or shareholder value.