ADVANCED

ACCOUNTING THEORY

Unregulated Corporate
Reporting Decisions:
Considerations of
System-oriented Theories

Narmada Balasuriya
B.Sc. Accounting (Special) – USJ, CIMA (UK)
Department of Accounting and Finance
Faculty of Business
System-oriented View

• Perceives an organization as being part of a broader social system in which the organization is influenced
by, as well as influences, the society in which it operates.
• ‘… a systems-oriented view of the organization and society … permits us to focus on the role of
information and disclosure in the relationship(s) between organizations, the State, individuals and
groups.’ - Gray, Owen and Adams (1996)

• System-oriented theories are also known as ‘open system theories’

• These are alternative theories which explain why organizations make voluntary disclosures in an
unregulated environment...
• Believe organizational boundaries are porous - Corporate disclosure policies represent one important
means by which management can influence external perceptions about their organization.
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System-oriented View

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Political Economy Theory (PET)

• Political economy is the ‘social, political and economic framework within which human life takes place’
- Gray, Owen & Adams(1996)
• The political economy perspective perceives accounting reports as social, political, and economic
documents. They serve as a tool for constructing, sustaining, and legitimizing economic and political
arrangements, institutions, and ideological themes which contribute to the corporation’s private interests.

• Corporate reports are not considered neutral and unbiased, but are a product of the interchange between
the corporation and its environment
- Guthrie and Parker (1990)

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Political Economy Theory (PET)

These theories explain and predict why managers would make voluntary non-financial and financial
disclosures. 5
Political Economy Theory (PET)

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Classical PET

• Considers class interests, structural conflict, inequity and the role of the state.
• Accounting reports and disclosures;
• A way of maintaining favored position (power and wealth) of those who control scarce resources
( elite class) and a way of undermining the position of those without scarce resources.
• This theory mainly focuses on the structural or class conflict within the society.

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Bourgeois PET

• Does not explicitly consider class conflict or structural conflicts.

• Ignores tension within society and accepts the world as pluralistic—> does not question the class structure

—> just explains the existence of different groups and their interactions.

• Accepts that power is widely diffused and no particular class as such dominates another

• Does not accuse the accountants for serving only the elite..

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Legitimacy Theory

• Legitimacy
• A state or a condition
• Congruence of organizational value system with that of the society
• A relative concept and time and place specific

• Legitimization
• Process that leads an organization to be legitimate

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Legitimacy Theory

• Asserts that organizations continuously seek to ensure they operate within the bounds of their respective
societies – society’s expectations
• Relies on the notion of a ‘social contract’
• They want to ensure that their activities are perceived to be ‘legitimate’
• Society’s expectations change so organizations must be responsive to changes.
• Legitimacy Theory proposes a relationship between corporate disclosure and community expectations
• Voluntary disclosures—> an effort to legitimize existence—>useful in case of an Unfavorable event that
puts legitimacy into question
• O’Donovan (1999) provided evidence that corporate managers believe that the media shapes public
concerns and annual report disclosures are a means of winning back the support of the community after
adverse media coverage

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Legitimacy Gap

• Lack of correspondence between how society believes an organization should act and how it is perceived
that the organization has acted.
• What matters is how the society perceives the conduct not the actual conduct

Downside of this?
• The gap will exist even if the conduct is congruent with social expectations. How?

• The gap also arises from changing social expectations with changing times and circumstances—> also if
the organization is slow in responding to the change.

• Doing the right thing is not sufficient....the society needs to know that you are doing the right thing....
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Legitimacy Gap
Islam and Deegan (2008) reviewed the social and environmental
disclosure practices of Nike and H & M 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
certain issues (creates a legitimacy gap) and managers will make
disclosure responses to the media attention.

Nike Sweatshops in developing countries such as Indonesia back in

90’s,
Apple’s supplier Foxconn – suicides and poor working conditions

https://www.newidea.com.au/nike-sweatshops-the-truth-about-th
e-nike-factory-scandal
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Actions to Legitimize Activities

• Substantive Technique
• Reflect actual change in the activities

• Symbolic Technique
• Reflect corporate image appearing to be
consistent with social expectations, but
actual operations have not changed—>
mainly through communication

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Actions to Legitimize Activities

• Adapt output, goals and methods of operation to conform to prevailing definitions of legitimacy. -

substantive

• Attempt through communication to become identified with symbols or values which imply legitimacy.

• Attempt through communication to alter the definition of social legitimacy so it conforms with the

organization’s present practices, output and values.

Downing and Pfeffer (1975)

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Communication to Maintain Legitimacy

• To educate and inform the community about the changes in

the performance and activities

• To change perceptions of organization’s performance and

activities but not its actual behavior.

• To manipulate perception by deviating attention from the

issue to other related issues.

• To change external expectations - show that specific

expectations are unreasonable.

Lindblom (1994)
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Stakeholder Theory

• Stakeholder theory;
• Identifies specific stakeholders and their stakes
• Acknowledges the differences among stakeholders and their stakes

• There are two (2) branches;

• Ethical (moral) branch or Normative Branch
• Positive (Managerial) Branch

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Stakeholder Theory
• Ethical or Moral Branch (Normative Branch)
• All stakeholders have the right to be treated fairly by an organization irrespective of power.
• Management should manage the organization for the benefit of all stakeholders.
• Management has a fiduciary duty to all the stakeholders – be accountable
• Under accountability model, ‘reporting’ is assumed to be a responsibility.
• Hence, the role of reporting (e.g. CSR reporting) is to provide the society at large with information
about the extent to which the organization has met the responsibilities imposed upon it....
• Managerial or Positive Branch
• Management will be likely to attend to the expectations of particular (powerful) stakeholders.
• Stakeholders are identified by the organization
• The more important a particular stakeholder is —> the more effort will be exerted to manage the
relationship.
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• Expectations of stakeholders considered to impact on operating and disclosure policies.
Role of Information Provided though Accounting

• Information including financial accounting and social performance information is a major element

employed to manage stakeholders.

• Information will be used to gain support, or approval or to distract their opposition or disapproval.

• This is consistent with the legitimization strategies suggested by Lindblom (1994)

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Institutional Theory

• Considers the forms organizations take and provides explanations for why organizations within a particular
‘organizational field’ tend to take on similar characteristics and form.
• Particular organizational forms might be adopted in order to bring legitimacy to the organization.
• “Organizations conform because they are rewarded for doing so through increased legitimacy, resources
and survival capabilities” (Scott, 1987)
• Institutions are comprised of regulative, normative and cultural-cognitive elements that together with
associated activities and resources provide stability and meaning to social life. (Scott,2008)
• Three Pillars
• Regulative
• Normative
• Cultural Cognitive
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Institutional Theory
• Regulative Pillar
• Rules, laws and associated sanctions
• Organizations would do certain things in a certain way or take a certain form because it is required
legally - if not followed organizations will be sanctioned or penalized.
• Normative Pillar
• Values and norms reflecting certain social obligations or expectations.
• Maintained through accreditations, professional endorsements and formal education.
• Organizations would do certain things in a certain way or take a particular form because it is the right
way to do that.
• Cultural Cognitive Pillar
• Taken-for-granted symbolic systems and meanings
• Maintained by the mimetic mechanisms in which the organizations tend to imitate others.
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• Organizations do things in a certain way because ‘it is how things are done’
What does Institutional Theory suggest?

• That organizations will appear to publicly embrace particular institutional forms due to regulative,
normative and cultural-cognitive influences.
• Organizations may not actually be practicing such things or structures/forms—> just showing to the public
that they are following a structure to gain legitimacy.
• They may have ‘decoupled’ their formal structure from informal (unseen) structure.
• The formal structure (seen by others) are isomorphic with institutional environment.

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