System oriented theories to

accounting practices
From Deegan, C. and Samkin, G.,
Financial Accounting. McGraw-Hill
Irwin, New York

A presentation by
Dewan Mahboob Hossain; Department of Accounting & Information
Systems; University of Dhaka; Dhaka; Bangladesh.
Prepared By: Dewan Mahboob Ho
ssain

Organization viewed as part of

a wider social system
Investors

employees

consumers

The public

The organization

Industry bodies

Interest groups

suppliers

Media

Govt.

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Two theories of system based

perspective
Legitimacy theory; and
Stakeholder theory.
Both these theories consider accounting
disclosure policies as a strategy to manage the
relationship between the organization and other
parties with which it interacts.
In recent years, stakeholder theory and legitimacy
theory have been applied primarily to explain
why organizations make certain social
responsibility disclosures within their annual
reports, rather than why they elect to adopt
particular financial accounting methods.
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Social responsibility
disclosure
Disclosure of information on the
interaction of an organization with
its physical and social environment.

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Stakeholder theory
Perspective that considers the
importance of an organizations
survival of satisfying the demands
of various stakeholders.
Stakeholder theory has both an
ethical (normative) and a
managerial (positive) branch.

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Ethical branch of stakeholder

theory
Managers should manage the business for the
benefit of all stakeholders.
Firm is not a mechanism for increasing the
stockholders financial returns but it is a vehicle
for coordinating stakeholders interests .
Management has a fiduciary relationship not
only to the stockholders but to all stakeholders.
Management must give equal consideration to
the interests of all stakeholders and when these
interests conflict, manage the business so as to
attain the optimum balance among them.

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Ethical branch of stakeholder

theory
In its normative form, the stakeholder
theory does imply that business has true
social responsibilities.
All stakeholders have a right to be
provided with information about how the
organization is affecting them even if
they choose not to use the information
and even if they cannot directly affect the
fate of the organization.

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Managerial branch of
stakeholder theory
The managerial branch of stakeholder theory seeks to
explain and predict how an organization will react to the
demands of various stakeholder groups.
The organization identifies its group of stakeholders,
focusing on those that are considered to be important to
the ongoing operations of the business.
The greater the importance of particular stakeholders, the
greater the expectation that the management of the form
will take action to manage relationships with those
stakeholders.
A major role of corporate management is to assess the
importance of meeting stakeholder demands in order to
achieve the strategic objectives of the firm.
As the level of stakeholder power increases, the
importance of meeting stakeholder demands increases
also.

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Managerial branch of
stakeholder theory
The power of stakeholders to influence
corporate management is viewed as a
function of stakeholders degree of control
over resources required by the
organization.
The more important the stakeholder-control
over resources required by the
organization, the greater the expectation
that stakeholder demand will be addressed.
A successful organization is considered to
be one that satisfies the demands
(sometimes conflicting) of various powerful
stakeholder groups.
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Managerial branch of
stakeholder theory
Stakeholders power will be stakeholder-organizationspecific, but might be tied to such things as command
of limited resources (finance, labor), access to
influential media, ability to legislate against the
company, or ability to influence the consumption of the
organizations goods and services.
According to stakeholder theory, information, including
financial accounting information and information about
the organization's social performance, is a tool in
controlling the sometimes conflicting demands of
various stakeholder groups.
Information is a major element that can be employed
by the organization to manage or manipulate the
stakeholders in order to gain their support and
approval, or to distract their opposition and
disapproval.

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10

Legitimacy Theory
Theory that proposes that
organizations always seek to
ensure that they operate within the
bounds and norms of their
societies.
These bounds and norms are
subject to change rather than being
fixed.
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Legitimacy Theory
Social contract: Concept used to describe
the right to exist accorded organizations by
society as long as they need societys
various implicit and explicit expectations
about how an organization should conduct
its operations.
It is assumed that society allows the
organization to continue operations as long
as it generally meets societys expectations.

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Legitimacy Theory
As Mathews (1993):
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
standings and attributes and the authority to own
and use natural resources and to hire employees.
Organizations draw on community resources and
output both goods and services and waste
products to the general environment. The
organization has no inherent rights to this benefits
and in order to allow their existence, society would
expect the benefits to exceed the costs to society.

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Legitimacy Theory

1.
2.
3.
4.

If an organization cannot justify its continued

operations the community might in a sense
revoke the organizations contract to continue
its operations.
For example,
reduction of demand for the products;
Interruption of supply of material, labor and
financial capital;
Increase tax and fines;
Incorporate law by the government.

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Legitimacy Theory
Organizations will take various actions to
ensure their operations are perceived to be
legitimate.
For example, provide disclosure in the annual
reports.
From the perspective provided by the
legitimacy theory, it is not only important that
organizations operate in a manner consistent
with community expectations, the organization
must also disclose information to indicate that
it is complying with community expectations.

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Legitimacy Gap
The difference between the
expectations of the relevant
public of how an organization
should act and how an
organization does act.

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Legitimacy
Lindblom (1994) defines legitimacy as a condition that
exists when an entitys value system is congruent with
the value system of the larger social system of which the
entity is a part.
This legitimacy is considered as a resource that helps the
organization to continue to operate in a society.
Any threat to this legitimacy can be harmful for the
organization.
Threats to an entitys perceived legitimacy are predicted
to lead to responsive actions by management who will try
to minimize such impacts of legitimacy threats and one of
these minimizing strategies is the disclosure-related
strategies (Islam and Deegan, 2008 and Woodward et al,
1996).

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Disclosure and legitimacy

Disclosure can be a solution to overcome the legitimacy
threats:
.a firm may provide information to counter or offset
negative news which may be publicly available, or it may
simply provide information to inform the interested parties
about attributes of the organization that were previously
unknown. In addition, organizations may draw attentions
to strengths, for instance, environmental awards won, or
safety initiatives that have been implemented, while
sometimes neglecting or downplaying information
concerning negative implications of their activities, such
as pollution or workplace accidents. (Deegan and
Unerman, 2006, p.274).

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