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Accounting Theories: Stakeholder, Institutional, and Legitimacy Theory Essay

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Updated: May 8th, 2022

A theory is defined as a set of principles that form the underlying structure that can be referred to in a discipline of study. Accounting, being a human activity, considers such things as the behaviour of people and their needs in regard to information that is financial in nature. It also considers why an organisation might choose to divulge or give information to a particular group of stakeholders. The theories of accounting date back to the early 1920’s when researchers were basically relying on observation. All through this period, there has been an attempt to prescribe how assets should be valued for the sake of external reporting, predict on what basis managers should be paid or motivated, predict the power of different stakeholders, and how the organisation aspires to be judged by the community.

This essay will discuss three accounting theories namely the stakeholder theory, legitimacy theory and institutional theory. It will show the major principles of each particular theory, its effectiveness, and weaknesses. For purposes of organisation, three subheadings will be used.

Stakeholder Theory

According to Freeman and Reed (1983), a stakeholder is any person or group of persons who has an effect on the accomplishments of an organisation’s goals or is affected by such accomplishments. The stakeholders can further be divided into two; primary and secondary. Without the continuous involvement of the former, a company cannot survive. For the latter, the company can still survive (Clarkson, 1995).

The stakeholder theory is further divided into two; ethical and managerial branch. The ethical branch argues the right to be treated fairly should be enjoyed by all stakeholders. The organisation should endeavour to give information to all stakeholders as soon as it is required without withholding anything. The managerial approach suggests that information should be given only when the organisation deems it prudent. The core belief of the manager’s approach is that information is a vital tool to manage stakeholders so as to win their acceptance and support. Further, the same information can be used to manipulate the stakeholders so as to avert disapproval and distract opposition.

The theory considers the organisation as part and parcel of the society. The major strength of this theory, especially the manager’s approach branch, is that it specifically considers how the different stakeholders should be best handled and managed so that an organisation not only achieves its objectives but also survives. Freeman and Reed (1984) assert that the task of those in management is to assess the benefits of living up to the expectations of shareholders and achieve the objectives of the firm. If all stakeholders are well coordinated, through voluntary exchanges, then each stakeholder will endeavour to give his best making it better for everyone (Freeman and Reed, 1984).

It has been found out that particular groups of stakeholders are more effective than others in regards to disclosure of social responsibility demands (Nue, Warsame and Podwell, 1998). Companies have been found to be more responsive to demands of stakeholders which are financial in nature and statutory requirements from governments but not from environmentalists or secondary stakeholders as defined by Clarkson (1995).

Legitimacy Theory

The theory stipulates that organisations aim to ensure that they function within the societal norms that they operate in. It is premised on a notion that a society has direct and indirect expectations from an organisation that is operating within their area. The organisation too expects some things from the society. The two therefore get it to what may be considered a social contract whose violations would attract repercussions. For example, the organisation must respect the rights of the inhabitants of the society in which it operates or face sanctions in the form of legal restrictions, or the society shunning the products of the firm altogether.

Firms undertake deliberate measures to ensure their activities are perceived as legitimate. They will seek ways to maintain this congruity by doing the following: Suit its goals to be in tandem with what the society deems legitimate, attempt through public relations department and communication to influence what society considers legitimate to correspond to the values of the firm, and identify with symbols that are heavily associated with legitimacy by the society.

Studies have linked social corporate disclosure policies to legitimacy theory. Research has shown that US Steel Corporation varied the degree of social exposures year to year. One can therefore say that this is caused by society’s changing expectation of firm’s behaviour. Researchers have also proved that the extent to which the media gives coverage to a particular issue is a measure of community’s concern. Brown and Deegan (1999) argue that the annual reports released by managements of firms are a tool to lend legitimacy to its operations. They (Brown and Deegen) also argue that influencing the community’s perception of what is legitimate or not is influenced by the media.

Institutional Theory

According to this theory, organisations take up practices and structures that have passed the test of legitimacy and have already been taken up by other organisations. According to Carpenter and Feroz (2001), such practices can be transmitted through three main ways namely pressure, coercion and imitation. Organisations tend to borrow norms and structures from other organisations based on consideration of social legitimacy more that the effectiveness of such norms and structures.

DiMaggio and Powell (1983) argue that the tendency to conform makes organisations similar without necessarily improving them. Governments and organisations with unclear and unreliable goals take legitimacy as an excuse to illustrate economic and social correctness while in actual sense, such organisation or governments as the case might be are simply ineffective.

This theory has been faulted for various reasons. It relies on a form of training professional accountants that entrench bureaucracy. Secondly, it stifles innovation. An accounting or management practice in one firm can not necessarily work well in a different firm. Thirdly, with the replication of practices, norms and values, negative values are also transferred. Systemic corruption and inefficiencies in one firm are directly implanted into another firm.

In summary, the paper has covered three accounting theories. In choosing the theory to adopt, organisations are guided by their goals and objectives. A non-profit organisation may choose a theory that is not profit oriented and vice versa. Other organisations may try to blend the theories and adapt to keep abreast with the dynamics of the society. Each theory has its own strength and weaknesses as we have seen and it is therefore upon the organisation to weigh and see the theory to employ based on its goals and objectives. Basically, an organisation aspires to remain legitimate and meet the expectations of all stakeholders.

References

Brown, N & Deegan, C 1998, ‘The public disclosure of environmental performance information- a dual test of media agenda setting theory and legitimacy theory’, Accounting and Business Research, vol 29,no.1,pp. 21-41.

Carpenter, V.L & Feroz, E 1990,’The decision to adopt GAAP: A case study of the commonwealth of Kentucky’, Accounting horizons, vol 4 no. 2,pp.67-78.

Clarkson,M.1995, ’A stakeholder framework for analysing and evaluating social performance’, Academic of management review, vol.20 no.1,pp. 92-97.

DiMaggio, P. J & Powell, W.W 1983,’ The iron cage revisited: institutional isomorphism and collective rationality in organisational fields’,American sociological, vol.48,no. 1,pp.147-160.

Freeman, R. E 1983,’Strategic management a stakeholder approach’,Advances in strategic management,vol.1,no. 1,pp. 31-60.

Nue, D., Pedwell H & K Warsame, H. & 1998,’ Managing public impressions: environmental disclosures in annual reports’, Accounting Organizations and Society,vol.25, no.1,pp.265-282.

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