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Module 4 Social Determinants of Financial Reporting.

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Presentation on theme: "Module 4 Social Determinants of Financial Reporting."— Presentation transcript:

1 Module 4 Social Determinants of Financial Reporting

2 Introduction u Traditionally, the only measure of firm performance was profit u However, public expectations have changed so that organisations are now required to address human, environmental and other social issues u Community perceptions can influence the disclosure policies of an organisation

3 Systems-oriented theories u Two systems-oriented theories- u Legitimacy theory u Stakeholder theory u Focus on the role of information and disclosure in the relationships between organisations, government, individuals and groups u The entity is influenced by, and influences the society in which it operates

4 Political Economy Theory u Legitimacy Theory and Stakeholder Theory are derived from Political Economy theory u Political economy ‘is the social, political and economic framework within which human life takes place’ u Economic issues cannot be investigated in the absence of considering the political, social and institutional framework within which economic activity takes place

5 Political Economy Theory— continued u Corporate reports not considered neutral and unbiased, but are a product of the interchange between the corporation and its environment u Legitimacy Theory and Stakeholder Theory can be applied to help explain why an entity might elect to make particular voluntary disclosures

6 Legitimacy Theory u Organisations seek to ensure they operate within the bounds and norms of their respective societies u activities are perceived to be ‘legitimate’ u bounds and norms not static so require organisation to be responsive u relies upon the notion of a ‘social contract’

7 Legitimacy and legitimation u Legitimacy is the status or condition which exists when an entity’s value system is perceived as congruent with that of the society u legitimation is the process which leads to an organisation being viewed as legitimate. This ‘process’ can include corporate disclosures.

8 Social contract u Represents the implicit and explicit expectations that society has about how the organisation should conduct its operations

9 Implications of not meeting social contract u Society allows the organisation to continue operations to the extent that it meets their expectations u the organisation may find it difficult to obtain the necessary support and resources to continue operations u may lead to sanctions such as legal restrictions on operations, limited resources provided, or reduced demand for products

10 Actions to legitimise activities u Adapt output, goals and methods of operation to conform to definitions of legitimacy u attempt, through communication, to alter the definition of social legitimacy so it conforms with the organisation’s present practices, output and values u attempt, through communication, to become identified with symbols or values which imply legitimacy

11 Communication to maintain legitimacy u Seek to educate and inform the community about changes in performance and activities u seek to change perceptions but not behaviour u seek to manipulate perception by deflecting attention from the issue to other related issues u seek to change external expectations

12 Role of public disclosure u Public disclosure in such places as annual reports can be used to implement each of the previous strategies u perspective adopted by many researchers of social responsibility reporting u highlights the strategic nature of financial statements and other related disclosures

13 Empirical tests of Legitimacy Theory u Used by researchers examining social and environmental reporting practices u used to attempt to explain disclosures u disclosures form part of the portfolio of strategies undertaken to bring legitimacy to or maintain legitimacy of the organisation

14 Conclusions from tests of Legitimacy Theory u Increase in disclosures following social incidents or environmental dissasters, and around proven environmental prosecutions u Increased disclosure over time associated with increased environmental group membership u Disclosures mostly positive

15 How management determines society’s expectations u Legitimacy Theory proposes a relationship between corporate disclosure and community expectations u management has been found to rely on the media, with the media being observed to shape community expectations

16 Legitimacy Theory versus Positive Accounting Theory u Legitimacy Theory has been compared to the Political Cost Hypothesis of PAT u Legitimacy Theory relies on the notion of a ‘social contract’ u it does not rely on the economics-based assumption that all action is driven by self- interest and wealth maximisation or make assumptions about the efficiency of markets u Why is it important to be legitimate?

17 Stakeholder Theory

18 Definition of stakeholders u 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 and Reed 1983) u Examples include shareholders, creditors, government, employees, employee’s families, local communities, and future generations

19 Stakeholder Theory u Two branches of Stakeholder Theory: u ethical (moral) or normative branch u positive (managerial) branch

20 Ethical branch of Stakeholder Theory u Normative theory - what ‘should’ happen u All stakeholders have the right to be treated fairly by an organisation u Management should manage the organisation for the benefit of all stakeholders u Each group merits consideration in its own right and has right to be provided with information, even if not used u Issues of stakeholder power are not directly relevant

21 Right to information— accountability u In considering rights to information accountability is considered: u the duty to provide an account or reckoning of those actions for which one is held responsible u accountability involves two responsibilities: u to undertake certain actions u to provide an account of those actions u reporting is assumed to be a responsibility rather than demand driven

22 Managerial branch of Stakeholder Theory u Attempts to explain when corporate management will be likely to attend to the expectations of particular (powerful) stakeholders u More organisation-centred u stakeholders identified by the organisation u extent to which organisation believes relationship needs to be managed in interests of the organisation u Expectations of stakeholders considered to impact on operating and disclosure policies

23 Stakeholder power u Organisation will not respond to all stakeholders equally, but to the most powerful u stakeholder power is a function of the stakeholder’s degree of control over resources required by the organisation u eg. labour, finance, influential media, ability to legislate, ability to influence consumption of the organisation’s goods and services

24 Stakeholder power— continued u Major role of management is to assess the importance of meeting stakeholder demands so as to achieve strategic firm objectives u expectations and power relativities of various stakeholders change over time u organisation must continually adapt operating and disclosure strategies

25 The role of information u Information, including financial accounting and social performance information, is a major element employed to manage stakeholders u used to gain support or approval u also used to distract their opposition or disapproval

26 Examples of empirical studies u Too early to draw overall conclusions from this area of research u Roberts (1992) u found measures of stakeholder power and their related information needs can provide some explanation of levels and types of corporate social disclosures u Neu, Warsame and Pedwell (1998) u firms more responsive (in terms of corporate environmental disclosure) to the concerns of financial stakeholders and government regulators than to environmentalists

27 Ethical view versus managerial view u 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 u Management will arguably be driven by both ethical and performance considerations

28 Legitimacy and Stakeholder Theories u Many similarities between Legitimacy Theory and Stakeholder Theory (managerial branch) u should not be treated as two separate theories but two (overlapping) perspectives of the issue set within a ‘political economy’ framework u Stakeholder theory specifically considers the different stakeholder groups within society, and how they could best be managed u not society as a whole like Legitimacy Theory

29 For Tutorials u Required reading u Text chapter 8 u Self assessment questions u Questions from module 4 u Answers in tutorials


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