Application of Social Contract to Legitimacy Theory in Accounting.

Question: Discuss about the Relevance and Application of Social Contract to Legitimacy Theory in Accounting. Answer: Introduction From last two decades, organization have progressively used their yearly reports to voluntarily report data indentifying with their social activities, especially showing their concern towards natural environment. Organizations are changing their disclosure policy, now they are showing social issue, environmental issue and political issue regarding the performance of the company. Legitimacy theory defined that organizations are bounded by social contract in which organization agrees to do social activities and in return they get authority to meet their objectives without any interference. Deegan (2002) explained that both the term legitimacy and legitimating are different. Legitimacy is the condition which exists when value of the organization is similar to the society whereas legitimation is the process because of which organization is able to view as a legitimate. In todays era, application of social contract to legitimacy theory in accounting plays an important role as it provide satisfaction that organizations actions are appropriate and desirable without harming the interest of the society. Legitimacy theory provides mechanism to understand voluntary disclosure made by the company. First, in this report we will discuss about ethical prospective and voluntarily disclosure of entity, then contract between entity and society in social contract, after that we will study how legitimacy theory overlapped stakeholder theory, institutional theory, and positive accounting theory. At last, summarizes with how to act legitimately for social contract. Relevance and Application of Legitimacy Theory In todays era, application of social contract to legitimacy theory in accounting plays an important role as it provide satisfaction that organizations actions are appropriate and desirable without harming the interest of the society: T Shank (2005). Business entity provides assurance to society that it is complying with the expectation of society. Social contract represents the expectation (implicit and explicit) of society about how business entity should perform its operations. In todays era it is very important to meet the need of the society. Organization have progressively used their yearly reports to voluntarily report data indentifying with their social activities, especially showing their concern towards natural environment. Organizations are changing their disclosure policy, now they are showing social issue, environmental issue and political issue regarding the performance of the company. Rankin, Voght (2000), used Legitimacy theory to show how disclosure regarding social i ssue in yearly report changed around the time. Gordon and Deegan (1996) concluded that increasing disclosure requirement has positive impact on organization. It improves the relationship between society and the organization. A business organization can select the audience which will become part of such disclosures. Media which is favored by business organization for disclosing social and environmental issue is the website of business entity, stand alone reports/ as part of yearly report of the organization. Ethical prospective and voluntarily disclosure of organization Intentional corporate social disclosure are literarily interceded talks which convey an "atmosphere of authenticity" are depended upon by pertinent public as portrayals of authoritative exercises, yields objectives as by large these are not promptly discernible. Voluntarily disclosure enrolls, reverberate enhance prevailing societal topics qualities. Organization influences and influenced by the society in which it perform its work. Traditional financial accounting is not useful because it focus on the information need of the shareholder; it avoids social and environmental disclosures. In todays era it is very important to meet the needs of the society: Saloman (2006) There should be triple bottom line reporting. Triple bottom line reporting considers the impact of social, environmental performance of an organization. Under legitimacy theory bounds and norms are not stringent, so organization needs to be responsive towards that. Patten (1992) explained that there is change in disclosure requirement of US oil mills which exists in Alaska. As per Legitimacy theory there is increase in the disclosure requirement of oil mills, which causes increase in overall disclosure requirement of the industry. Accounting disclosure is the strategy of the organization to manipulate the relationship the relationship of organization with society-ML Defnd (1998). Voluntarily public disclosure in annually report of the organization can be used to implement previous legitimating strategies of the organization. There can be two forms of voluntarily disclosure, one is substantive disclosure another is symbolic disclosure. In substantive disclosure actual changes in organization will be reflected whereas in symbolic disclosure actual changes will not be reflected, but they are made to aligned with social values and expectation of the society: Jo and Kim (2007). Various researchers examined the need of voluntarily disclosure which includes social and environmental disclosure. They also examined the changing pattern in disclosure requirement. To maintain legitimacy in the entity, it is beneficial to provide voluntarily disclosure of social and environmental issue in annual return: Botason (1997) As per ODonovan (1999), organization assumed that media give shape to the concern of the public and yearly report disclosure provides opportunity to the company to cover from negative media coverage. The relation between social contract and financial performance of the organization is very important. According to Oberman (2000), in late 1920, some organizations were doing voluntarily disclosure. Impact of voluntarily disclosure is very dynamic. One sole motive of voluntarily disclosure and ethical reporting is to bring transparency in the reporting system and society must be aware of organizations activities- Walsh (2003). Society has right to information about the organization. It is the duty of the entity to provide voluntarily disclosure regarding social responsibility (social and environmental) to the society. Rankin, Voght (2000), used Legitimacy theory to show how disclosure regarding social issue in yearly report changed around the time. Gordon and Deegan (1996) concluded that increasing disclosure requirement has positive impact on organization. It improves the relationship between society and the organization. Reporting by entity is assumed as a responsibility of entity rather than demand. There are 2 types of responsibility under accountability: one is to take action and another one is to provide a report on those actions which are undertaken by management of the entity. Voluntarily disclosure with financial disclosure helps the organization to get an edge in the market. It is also used to get support from society by fulfilling their demands. Voluntarily disclosure as the term says all, it is not compulsory for the organization to disclose social and environmental issue but if organization perform its function according to norms and by meeting the expectation of society, then definitely that entity will get an edge in the market- Burgstahler (1997). So, organization should perform its activities ethically by considering the need of the society. Sustainability reporting defines that how present activities of the organization are effecting abilities of future generation to fulfill their nee ds. If society wants sustainability reporting from organization then in this case sustainability reporting must be aligned with legitimacy theory to achieve the objective of organization effectively and efficiently. By providing information to the society regarding social, economic and environmental performance of the organization, it will build the trust among society- MH (1996) A great part of the interest for corporate social disclosure can be seen as the consequence of open yearning for data on which to base a supposition about regardless of whether a business organization "suitable" or "right and legitimate" that is , to assess the authenticity of business organization. In addition, a great part of the intentional social divulgence issued by enterprises which can be seen as endeavors at legitimating, that is endeavors to accomplish the status of authenticity" Most of the business organisation voluntarily discloses social information in their annual report. These voluntarily disclosures can take the form of management discussion in yearly reports of the organization or separate disclosure (For example: stand-alone, social, sustainability or environmental report). But the format and content of the stand alone, social, sustainable and environmental disclosure is not provided anywhere. Global reporting initiative which is also known as GRI came into existence in 1997. Global reporting initiative provides guidelines for reporting of social issue, environmental issue and political issue by business organization. The latest version (that is third) of Global reporting initiative was came into existence in 2003(which is known as G3)-Chung (1996). Because of this business organization provide reporting on social issues. The business organization will decide what they have to report, how they will report, and at what level, business organization wil l provide detail to the society regarding social issue. Information inductance is an example of voluntarily social disclosures. A business organization can select the audience which will become part of such disclosures. Media which is favored by business organization for disclosing social and environmental issue is the website of business entity, stand alone reports/ as part of yearly report of the organization. Contract between entity and society in social contract Thomas Hobbes introduces the theory of social contract. Social contract is a contract between which exists between business entity and society where business entity perform its operation. Under social contract two aspects are covered, one is explicit expectation of society from organization, another one is implicit expectation of society from organization. Implicit expectation can be defined as expectation of the society from the business entity, whereas explicit can be defined as legal requirement which organization have to fulfill to operate its business activities effectively and efficiently. Lindblom (1994) concluded that legitimacy theory based upon a notion that there should be social contract between society and organization. A social contract is a contract which defines implicit and explicit expectation of society from the organization. Explicit term can be defined as legal requirement which organization has to fulfill and implicit term can be defined as society expectation. Business entity provides assurance to society that it is complying with the expectation of society. Social contract represents the expectation (implicit and explicit) of society about how business entity should perform its operations: Dechow (1994).During golden years (old time), there was only one measure to know the performance of organization, that was profit maximization. It means that the more company will earn profit, the better it is. Other factors were ignored during that period. But nowadays expectation of public has changed- S Seficik (2004). Now, business entity performs its operation by considering the need of the society. Now, business entities have to disclose social issue, political issue and environmental issue in their annual report. Organization has to tell whether they are compliance with laws and regulation which are levied upon them-EF (1970) Implications if business entity is unable to meet the social contract Society gave permission to business entity to perform their activities by fulfilling their needs. Business organization has to compliance with legal, social and political requirement. But sometimes, business organization faces the problem of legal restrictions which are levied upon them. If business organization is unable to meet the social contract then it will not be able to perform its task (operation) effectively and efficiently. When restriction is imposed upon resources of the business organization then it will not be able to fulfill the demand of customer, and its market share will decline. It is very important for business organization to meet the expectation of society because if business organization will not do so then it will lose its market share and its competitor will get an edge in the market. Social contract is very important for legitimacy in accounting. Social contract provides foundation to the legitimacy theory in accounting. So, it becomes important for organization to consider the demand of society while performing its operation. Social contract theory defines the moral obligation of business organization towards the society. Social contract theory is similar to political theory as per Hobbes. In the 21st century, social contract in legitimacy theory regained momentum in the business organization. Social contract theory provides importance to morality. Social contract defines laws, rules which organization has to follow while performing their operation. Now because of social contract which exists between society and business organization, entity perform their operations by considering environmental, social and political issues. It has a positive impact in the society as a whole. Now there is more accountability. It brings transparency in the system. Social contract is very important in todays era as expectation of society is increasing; they want that business organization should perform their task by fulfilling their expectation. Earlier there was only one sole objective of business organization, that was profit maximization or wealth maximization, which means that increase the earning for the shareholders in any way by ignoring all other factors (social factor, environmental factor and political factor). Now Business organization has to consider all the other factors (social factor, environmental factor and political factor) while maximizing the profit for their shareholder. It can be concluded that it is the positive step for the development of society as a whole. Now business organizations are more accountable and it brings transparency in the system. Main motive of social contract is to bring freedom in the society: It means that society has right to exercise their freedom as per Hobbes. Another main motive is to promote rational interest in the society. According to Hobbes concept of social contract between society and the business organization promote rational interest. Another main motive of social contract between society and the business organization is to bring equality in the society. Equality can be defined in terms of equality of need of the society, Equality for resources (scarce resources) and equality oh power of human. Another main motive of social contract between society and business organization is to promote justice relations. It has two dimensions, one is normative dimension and another one is empirical dimension. Last but not the least, motive of social contract between society and business organization is to raise the sovereignty and interest if individual. These all are the basic motive of social contract. I t can be said that it is the positive step for the development of society as a whole. Legitimacy theory overlapped stakeholders theory, intuitional theory, positive accounting and focuses on social contract and responsibility towards society. All the theories-stakeholders theory, positive accounting theory, legitimacy theory are based upon system. The main aim of these theories is to disclose the relationship between society and the business organization regarding disclosure of information. The business organization influences society in which it performs its operations and vice versa. Political economic theory provides basis for Legitimacy theory and stakeholder theory: Fama (1993). As per Ownes (1996), political theory provides framework for the social, economical and political issue. When there is no Political theory, then in that case economic reporting cannot be done by the business organization. Under political theory, reporting done by business enterprise is the exchange of goods between business organization and environment in which it operates. There are two aspects of theory: one is classical aspect, another one is Bourgeois aspect. The main motive of classical aspect of political economic theory is to reduce or minimize the conflicts in the society. Social disclosure by business organization provides transparency regarding the scarcity of resources: Friedman (1970). But bourgeois aspect of political theory does not provide attention to conflicts in the society. The main motive of bourgeois aspect of political economic theory is to consider the interaction of society with the organization. Both legitimate theory stakeholder theory are originated from bourgeois political economic theory. Stakeholder theory has 2 branches: one is ethical branch (it is also known as normative branch) and another one is positive branch (it is also known as managerial branch). There is so much common in both the theories (stakeholder theory legitimacy theory). Both theories are originated from positive economic theory, but legitimacy theory overlapped stakeholder theory. According to Reed (1983), stakeholder is a group of people who has impact upon organization or vice versa (which means that, activities of the business organization have also impact upon group of individuals). Stakeholders are connected to business organization as their interest is connected to business organization. The main motive of stakeholder theory is to avoid the conflicts between business organization and stakeholder and promote the rational interest of the stakeholder. Stakeholder of the organization has right to get information from management of business organization regarding their performance. Stakeholders can be of 2 types: one is primary stakeholder and another one is secondary stakeholder. Primary stakeholders are those stakeholders who participate in day to day functioning of the business organization, with whom business organization is unable to perform its daily task: Strawer (2001). Examples of primary stakeholder are managers of the business organizations, employees of the business organizations; where as secondary stakeholders are those stakeholders who do not intervene in day to day functioning of the business organization. They are not involved in daily routine in business organization but they have impact upon the organization and they can be influenced by activities of business organization. Example of secondary stakeholder is: shareholders. Shareholders of business entity do not intervene in day to day functioning of business entity but activities of business entity can af fect shareholders and vice versa is also true. As per stakeholders theory, Stakeholders have right to get information from business enterprise regarding the performance. When stakeholder ask the business entity to provide the information regarding the performance of company, then in that business entity cannot deny to stakeholder, company is bounded to provide necessary information to the stakeholder. Information which is provided by company can be assumed as a responsibility of the business organization. There is a managerial branch of stakeholders which examine that whether business organization is fulfilling the expectation of stakeholder or not- Evan and Freeman (1988) Under stakeholder theory, only some group of individual is considered by the business organization whereas in legitimacy theory whole society is considered by the business organization. Stakeholder theory is narrow in terms whereas legitimacy theory is wider in terms because legitimacy theory considers society as a whole whereas stakeholder theory only considers particular group of individual. It can be said that Legitimacy theory overlapped stakeholder theory, besides both the theories are common because both the theories are originated from Positive economic theory- Ullman (1985). There are 2 aspects of stakeholder theory; one is ethical aspect whereas another one is managerial aspect. But the management of the business organization is controlled by both the aspects. Sometimes, Legitimacy theory is compared with Positive accounting theory (hypothesis of political cost). But, social contract provides foundation for legitimacy theory. Legitimacy theory does not depends upon assumption (economic based), according to economic based assumptions all the facts are controlled by profit maximization whereas positive accounting theory is based upon such principle: Starks (2003). Thus, it can be said that legitimacy theory is wider in terms and provides holistic view of the business organization whereas positive accounting theory is narrow in term and does not provide holistic view of the business organization. Positive accounting theory ignores non cost factor whereas Legitimacy theory considers the entire non cost factor, so that organization can perform its function by fulfilling the needs and expectations of society where it operates. It also brings transparency in the system of the business enterprise. It can be concluded that Legitimacy theory overlap ped positive accounting theory (Hypothesis of political cost): Hamilton (1993). Institutional theory is a theory which provides linkage between practices of business organization with social values. Under institutional theory, business organization is inclined towards type of uniformity. As per DiMaggio Powell (1983), there are 2 aspects of institutional theory, one is isomorphism and another one is decoupling. Isomorphism can be defined as process of limiting the power of 1 segment in the population to match the remaining segments that will face same kind of environmental issues. There are 3 processes which come under isomorphic aspect of institutional theory: one is coercive, another one is mimetic and last one is normative. Coercive process is similar to stakeholder theory (managerial branch), in coercive process of isomorphism, business enterprise changes its normal practice due to the influence of the stakeholder upon the business enterprise. Stakeholders who are strong can have same expectation from another business entity: Healy (1999). Under Mimetic pro cess of isomorphism, business enterprise took ideas from its competitor to take an edge over its competitor and it will help to overcome the risk of uncertainty in the business entity. Under normative process of isomorphism, people particular pressurize the business entity to implement particular practice. Another aspect of institutional theory is decoupling, under decoupling, manager of the business entity founds that there is a need to implement particular practice, which can varies from present practice which is followed by the business enterprise. It can be said that legitimacy theory overlapped institutional theory as well- Malin (2006). Legitimacy theory is very important in todays world. It plays a vital role in the development of society as a whole. It also helps business organization to achieve its goal effectively and efficiently by meeting the expectation of society, by following rules and regulation which are implied over business entity under social contract. Legitimacy theory is verified through various processes. Many researchers analyzed the requirement of social, political, environmental disclosure in the business organization. Here are some examples of empirical studies (for legitimacy theory) Patten (1992) explained that there is change in disclosure requirement of US oil mills which exists in Alaska. As per Legitimacy theory there is increase in the disclosure requirement of oil mills, which causes increase in overall disclosure requirement of the industry. Deegan (2002) explained that both the term legitimacy and legitimating are different. Legitimacy is the condition which exists when value of the organization is similar to the society whereas legitimating is the process because of which organization is able to view as a legitimate. Lindblom (1994) concluded that legitimacy theory based upon a notion that there should be social contract between society and organization. A social contract is a contract which defines implicit and explicit expectation of society from the organization. Explicit term can be defined as legal requirement which organization has to fulfill and implicit term can be defined as society expectation. Rankin, Voght (2000), used Legitimacy theory to s how how disclosure regarding social issue in yearly report changed around the time. Gordon and Deegan (1996) concluded that increasing disclosure requirement has positive impact on organization. It improves the relationship between society and the organization. Legitimacy theory is the theory which provides the relationship between disclosure requirement of business enterprise and expectation of the society from business enterprise. As per ODonovan (1999), organization assumed that media give shape to the concern of the public and yearly report disclosure provides opportunity to the company to cover from negative media coverage. The relation between social contract and financial performance of the organization is very important. According to Oberman (2000), in late 1920, some organizations were doing voluntarily disclosure. Impact of voluntarily disclosure is very dynamic. Legitimating theory focus on social contract and it explains the responsibility of the business organization towards the society. Social contract provides foundation to the legitimacy theory. It can be concluded that all the theories are important for the development of society and business organization. Application of particular theory depends upon the circumstances under which business organization is doing its operation. Legitimacy theory overlapped stakeholders theory, intuitional theory and positive accounting theory which are discussed above. As social contract plays an important role in legitimacy theory. Application of social contract in legitimacy theory brings transparency in the system and helps the society as a whole in many ways as discussed above. Act legitimately for social contract Business organization should act legitimately by providing relevant information to the society and by fulfilling their expectation. If organization will act legitimately then automatically it will achieve its goal effectively and efficiently, it provides edge to the organization over its competitor- Lang (1991). Organizations are changing their disclosure policy, now they are showing social issue, environmental issue and political issue regarding the performance of the company. In todays era, application of social contract to legitimacy theory in accounting plays an important role as it provide satisfaction that organizations actions are appropriate and desirable without harming the interest of the society: T Shank (2005). Business entity provides assurance to society that it is complying with the expectation of society. Social contract represents the expectation (implicit and explicit) of society about how business entity should perform its operations. Social contract is very import ant for legitimacy in accounting. When stakeholder ask the business entity to provide the information regarding the performance of company, then in that business entity cannot deny to stakeholder, company is bounded to provide necessary information to the stakeholder. Information which is provided by company can be assumed as a responsibility of the business organization. A business organization can select the audience which will become part of such disclosures. Media which is favored by business organization for disclosing social and environmental issue is the website of business entity, stand alone reports/ as part of yearly report of the organization. As per Thomas Hobbes (1985), in todays era it is very important to fulfill the expectation of society. Expectation of society has changed, now social issues, environmental issues are to be considered by organization. Social contract provides foundation to the legitimacy theory in accounting. So, it becomes important for organization to consider the demand of society while performing its operation. Conclusion It can be concluded that social contract provides foundation to the Legitimacy theory. We address the importance of disclosure of social information, environmental information. From last two decades, organization have progressively used their yearly reports to voluntarily report data indentifying with their social activities, especially showing their concern towards natural environment. Organizations are changing their disclosure policy, now they are showing social issue, environmental issue and political issue regarding the performance of the company. Now because of social contract which exists between society and business organization, entity perform their operations by considering environmental, social and political issues. It has a positive impact in the society as a whole. Now there is more accountability. It brings transparency in the system. Social contract is very important in todays era as expectation of society is increasing; they want that business organization should perf orm their task by fulfilling their expectation. Legitimacy theory overlapped stakeholders theory, intuitional theory and positive accounting theory which are discussed above. As social contract plays an important role in legitimacy theory. 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