Assignment on Accounting Theory

Course Code:4201

Submitted to:

Dr. Md. Saiful Alam

Associate Professor

Dept. of Accounting & Information Systems

University of Dhaka.

Submitted by:

Nabanita Islam

ID: 23-179

Dept. of Accounting & Information Systems

University of Dhaka.

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Question#1

From your reading and attending the classes, how do you define accounting
theory? Why accounting students should read accounting theory? Using
empirical reference, compare and contrast among different paradigms of
accounting.Considering yourself as an independent researcher/explorer,
which paradigm suits you the best? Why?

Answer:
“Accounting theory is logical reasoning in form of a set of principles that -

(a) Provide a general frame of reference by which accounting practice can be evaluated; and

(b) Guide the development of new practice and procedures.”

E. S. Hendriksen

Thus, theory refers to a set of statements, which provides logical reasons behind events and
phenomenon. Accounting theory explains accounting practices and guides to keep pace with fast
changing environment. It is dynamic in nature and is based on sound logical reasoning. It helps
to build an approach towards accounting practices. It covers not only present scenario, but also
covers future development in an economy. Thus, Accounting theory refers to the brief set of
principles, doctrines, conventions, concepts related to accountancy, evolved by analysing the
accounting practices.

The cliché, accounting is the language of business has been around for many years.

Knowledge can only exist through communication and language is the most common

media of communication. Therefore to understand how knowledge of accounting is

established it is useful to study language. And if accounting is the language of business

this becomes even more important. However, the study of language is highly complex

and there are several ways by which this may be undertaken. The Ancient Greeks saw

language as comprised of signs and a common word for the study of language, semiotics

(or semiology in Europe), has Greek origins (interpreter of signs). Other terms used in the

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study of language include linguistics, rhetoric, hermeneutics and discourse analysis (and

Many others).

About the same time that Saussure, in Europe, was developing his semiotics, his theory of

language (which was to become the basis of structuralism as mentioned above), one of

America’s most important philosophers, Charles S Peirce, was creating his semeiotic, his

theory of signs which he believed extended to a whole system of philosophy. Peirce was

also the founder of pragmatism, the theory that holds that a proposition is true if holding

it to be so is practically successful or advantageous. He also greatly influenced the

development of logic.

Saussure was primarily concerned with the development of a theory of language central

to which is the notion of the sign which is, in turn, a combination of the paired elements

of signifier and signified. The signified is the concept (for example of “catness”) and the

signifier is the sound image (the sound –spoken – or sound image, “cat”). One thing to

note is that the sign is arbitrary, that is, they can differ from one language to another. It is

also important to realise that not only are different signs used in different languages this

leads to users of those signs thinking differently: the influence of culture which shapes

the way people think. In “accounting language” the word asset is a signifier and the

concept of asset (“assetness”) is the signified but just what is the concept of asset has

As indicated in the previous section, Saussure’s work was primarily intended as a theory

of language. However, it was taken up by other disciplines such as anthropology by,

Levi-Strauss, psychology by, for example, Lacan and in many other disciplines including

economics. The ultimate aim was to determine the underlying structures. Two other

features become evident. First, if underlying structure are sought then the individual

(human) is no longer relevant because she or he exists independent of the underlying

structure. Secondly, such analysis is synchronic, it is ahistorical – structures are

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independent of time. The opposite of synchronic is diachronic – changing over time.

Structuralist analysis, therefore, ignores history and development. To some scholars who

originally subscribed to structuralism this was a naïve understanding of how language

actually works. Therefore they rejected structuralism (as it stood) and sought ways of

extending or changing it to make it more reflect the fact that language changes over time

depending on how individuals and societies interpret the signs contextually. These

scholars came to be known as poststructuralists (because they came “after”

structuralism) but they developed their ideas in very different directions and all rejected

the label. The common features of their work are first, a recognition that language is

viewed as the medium for defining and contesting social organization and subjectivity.

Secondly, they hold that individuals are knowing and rational subjects and are necessary

for the creation of knowledge.

These views can be compared to the mainstream positivist notion of knowledge. To the

positivists knowledge was comprised of uncovering the elements of a real world and

formulating the knowledge in a neutral theoretical language. The individual therefore is

only a “device” for uncovering this knowledge. The postructuralist view is quite the

opposite – it is through language that knowledge comes into existence and this language

is comprised of a socially derived and accepted set of signs which every individual

interprets in their own way. Two of the most well known of the so-called postructuralists

are Michel Foucault and Jacques Derrida. Foucault turned to history, Derrida took

language and meaning to the extremes, breaking it down, deconstructing it into its barest

elements. There are several studies in accounting which have adopted a Foucauldian

approach but very few who have employed Derrida’s analysis.

Foucault was one of the most influential thinkers in the second half of the twentieth

century and still exerts a strong influence on theory in the social sciences and philosophy

so it is little wonder that some accounting researchers have been attracted to his ideas.

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Foucault is a notoriously difficult person to categorise but there are three phases of his

work. In the first he referred to the method as archaeology and it displays his structuralist

roots although it has moved well beyond Saussurean structuralism. The method in his

second phase he called genealogy and in the third phase it is described as being

concerned with discourse ethics. Themes found in his work include history, language,

discourse, subjectivity and power.

Question#2

Do you think that accounting regulation is necessary? Provide appropriate

arguments to support your position. What national and international factors
induce Bangladesh to go for a wholesale adoption of IFRS? Explain with
empirical reference the influence of cultural factors in accounting regulation.

Answer:
A regulatory framework for the preparation of financial statements is necessary for a number of
reasons: To ensure that the needs of the users of financial statements are met with at least a basic
minimum of information. For increasing users' confidence in the financial reporting process.
Accounting standards ensure the financial statements from multiple companies are comparable.
Because all entities follow the same rules, accounting standards make the financial statements
credible and allow for more economic decisions based on accurate and consistent information.

IFRS is the accounting standards of UK and USA (Briston, 1990). According to Briston (1990)
and Wallace (1990), countries which were part of British Empire have professional accounting
body and company legislation based on British model. Bangladesh was a part of British colony
for more than 200 years. Bangladesh’s Company Act as well as the accounting standards follows
the British framework. There are other reasons which force developing countries to follow the
accounting standards and practices of developed countries such as the British model. The British
professional accounting bodies offer professional qualifications overseas. This plays a very

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important role to improve the quality of accountancy in developing countries (Briston, 1990).
Institute of Chartered Accountant in England and Wales (ICAEW) is working closely with
Institute of Chartered Accountant Bangladesh (ICAB) to develop the skills of Bangladesh’s
accountants and auditors (ICAEW, 2008). Countries which do not have an organised body of
accounting principles emulate the systems of other countries (Wilkinson, 1965). This stands true
for developing countries like Bangladesh which do not have any structured accounting body.
Developing countries adopt the best practices in accounting standards from countries like UK
and USA. In the recent time there has been significant increase in the global commercial
activities. The participants of the global trade are both developed and developing countries. This
increase in world trade has urged the need of uniform accounting standards. IFRS is such
accounting standards which have led to eliminate the global accounting differences (International
Accounting Standard Committee, 1988). Increase in international trade and investment forces the
developing nations to reduce the differences in accounting reports with developed countries
(Chamisa, 2000). Different accounting standards create differences in financial accounting
measurement and reporting practices (Evans and Taylor, 1982). Moreover, they also create
misunderstanding and uncertainties to the participants of global economy (Evans and Taylor,
1982). Unlike most of the developed and developing countries, Bangladesh has also adopted
IFRS in 2006 (Mir and Rahman, 2005). Due to cheap labor force and geographical location,
Bangladesh is considered as an ideal country for investment in recent times. In order to meet the
requirements of foreign investors’ accounting standards, Bangladesh has adopted IFRS
(Akhtaruddin, 2005). Moreover, the textile industry in Bangladesh is booming. The country
exports most of its garment product to European and US markets. So, in order to participate in
international trade, it is very important for the local businesses to follow accounting standards
same as their trading counterparts (mainly European countries and US). It is argued by Wallace
(1990) that substantial investment or trading activity may not be the only reason to change the
accounting system of a country. Sweden has significant investment in Brazil, but the financial
reporting standard of Brazil is not as same as Sweden. So, trading and investment are not only
the issues which enforce country to undertake globally accepted accounting standards. There are
other issues which force countries (particularly developing countries) to adopt IFRS.

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The largest hurdle facing the implementation of a single set of high-quality international
accounting standards is the vast array of societal values embodied in different cultures. These
values are inherently interconnected with many defining aspects of society such as: language,
religion, education, and economy. Therefore, differences in values are accompanied by
differences in crucial aspects of society, and it is these numerous differences that can make it
incredibly difficult to apply one set of standards to the entire world. The goal of convergence as
well as the eventual comparability of international accounting standards is a feat that cannot be
achieved without the consideration of the cultures of the adopting jurisdictions. Previous works
have established that there is a connection between a society’s culture and the accounting system
that it uses. Therefore, the differences that exist between the values of nations will translate to
differences in accounting systems. The IASB has 31 the daunting task of addressing all of these
differences to try and bring about international convergence. This goal has been met with
resistance, however. Many adopting nations have done so only through locally endorsed IFRSs.
This has allowed for nations to make carve-outs to IFRS to better mold it to their own values. As
a result, there is not one set of standards, but several sets that are each specific to the jurisdiction
making the changes. The IASB also faces the challenge of applying IFRS to societies that don’t
align well with the western influences present within the standards. These societies have such
stark differences in aspects such as language, religion, education, or economy that at the present
moment do not align well with IFRS. The most obvious being Islam and the very specific
method of accounting that entities abiding by its rules must follow.

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Question#3

“There is a goal incongruence between managers and shareholders”- Explain

the theoretical underpinnings of this statement. How managerial contracts
minimize such incongruence?

Why managers show opportunism when contractual mechanisms are in

place? Is there any alternatives to reduce such opportunistic behavior?
Substantiate your answer with appropriate empirical reference.

Answer:

Goal congruence is the term which describes the situation when the goals of different interest
groups coincide. A way of helping to achieve goal congruence between shareholders and
managers is by the introduction of carefully designed remuneration packages for managers which
would motivate managers to take decisions which were consistent with the objectives of the
shareholders. Agency theory sees employees of businesses, including managers, as individuals,
each with his or her own objectives. Within a department of a business, there are departmental
objectives. If achieving these various objectives also leads to the achievement of the objectives
of the organization as a whole, there is said to be goal congruence.

A psychological contract breach occurs when an employee perceives that the organization has
failed to fulfil its obligations (Robinson & Rousseau, 1994). Breach, which is likely to happen in
situations of organizational change, affects employee behaviour and attitudes (Morrison &
Robinson, 1997; Robinson, 1996). A longitudinal three-wave study by Freese et al. (2011) in
three organizations in the care sector showed that the perception of psychological contract breach
increased during organizational transformations. The findings of other studies (e.g. Beaumont &
Harris, 2002; Ghoshal & Bartlett, 2000) on downsizing, outsourcing, and using contingent work
arrangements indicate that employees perceived to a greater extent that the organization was
failing to meet its obligations. Breaches of the psychological contract may change the nature of
the social relationship as a whole (MacNeil, 1985; Robinson & Rousseau, 1994), leading to a
decrease in trust. Trust is ‘expectations or beliefs regarding the likelihood that another's future
actions will be favourable, or at least not detrimental, to one's interests’ (Morrison & Robinson,

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1997, p. 238). Trust of an employee in the organization consists of several elements (Mayer et
al., 1995): ability (e.g. financial resources and non-financial resources), benevolence (e.g.
loyalty, openness, caring, and supportiveness), and integrity (e.g. fairness, justice, consistency,
and promise fulfilment) of the organization. A meta-analysis showed that mistrust is an
immediate affective response to a psychological contract breach (Zhao et al., 2007). There is
strong support for an association between psychological contract breach, trust, and attitudinal
and behavioural outcomes, such as job satisfaction, organizational commitment, and
organizational citizenship behaviour (Bal et al., 2008; Kowalski & Cangemi, 2005; Robinson,
1996; Robinson & Morrison, 1995; Robinson & Rousseau, 1994; Van den Heuvel, 2012; Zhao et
al., 2007). Literature falls short, however, in identifying how a psychological contract breach can
be mitigated or remedied. Certain conditions or provisions may influence the perception of
psychological contract breach. Previous research has identified remediation as an important
factor influencing the psychological contract (Bankins, 2012; Rousseau, 1996; Turnley &
Feldman, 1999). This is relevant for organizations that need to introduce financial retrenchments
to cope with changes in the environment (as was the case for the organization where this study
took place).

When a changing organization has not fulfilled the promises on one or more obligations in the
psychological contract, the organization can try to remediate this by offering employees other
inducements (Turnley & Feldman, 1999). Remediation implies that the organization substitutes a
new inducement for an obligation that cannot be fulfilled. In this way, an attempt is made to
decrease the size of the loss perceived by the employee and therefore to reduce the consequences
of an experienced loss on one or more obligations of the psychological contract (Rousseau,
1995). According to Social Exchange Theory (Cropanzano & Mitchell, 2005), reciprocal social
exchanges are comprised of actions that are contingent on the reactions of others. These provide
the basis for mutually rewarding transactions and further development of relationships. Gouldner
(1960) suggests there is a universal ‘norm of reciprocity’ (Gouldner, 1960). The resource theory
of Foa and Foa (1974, 1980) provides more specific propositions on which inducements can
substitute one another. The resource theory distinguishes six types of resources that can be
exchanged in an interpersonal relationship: love, status, information, money, goods, and services.
These resources can be classified into two dimensions. The first dimension displays the

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particularism (vs. universalism) of a resource, which means that the worth of the resource
depends on its source. Money scores relatively low on particularism since it does not matter from
whom people receive the money. Love, however, scores high on particularism, because it matters
a great deal from whom people receive love. The second dimension displays the concreteness of
the resource, which means how specific or tangible the resource is versus how symbolic it is.
Generally speaking, goods and services are at least somewhat concrete, since these are overtly
tangible products or activities. Status and information, however, can be classified as less concrete
resources that provide symbolic benefit. In addition to the identification of what is exchanged,
Turner et al. (1971) argue that the resources proximal to each other in the classification will be
perceived as more similar and substitutable for one another. It seems likely that psychological
contract obligations proximal in the categorization on the two dimensions of concreteness and
particularism will compensate better than distal aspects. Bankins (2012) showed that an
organization can buffer the negative effects of a psychological contract breach through
facilitating positive workplace social relationships and through providing challenging and
meaningful work, which are both parts of the psychological contract. Remedies, in the form of
the fulfilment of other obligations, can repair the negative experiences of a psychological
contract breach (Bankins, 2012). It is unknown, however, which specific inducement can
compensate a breached obligation in the psychological contract. Although Foa and Foa (1974)
provide a general guideline for substituting resources, there is a need for more empirical studies
examining these ideas.

Communication seems to be critical to the psychological contract in situations of organizational

change, because of its associations with uncertainty, incongruence, and attributions. In uncertain
situations, employees are more vigilant and therefore they will be more likely to notice and react
to psychological contract breaches (McLean Parks & Kidder, 1994). By giving accurate and
timely information, uncertainty may be reduced or even eliminated, with lower chances of
psychological contract breach being experienced (Chaudhry et al., 2009). Furthermore, truthful
and accurate communication between an employee and the agent(s) responsible for fulfilling the
employee's psychological contract is likely to reduce incongruence (Ross et al., 1977). Finally,
when people are faced with unfavourable outcomes, individuals have the tendency to look for
explanations that will enable them to attribute responsibility (Wong & Weiner, 1981). Managing

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attributions by providing appropriate and timely information can help to prevent negative
reactions of the employee (Chaudhry et al., 2009). Bankins (2012) found that open and honest
communication of organizational changes may buffer the negative consequences of a
psychological contract breach. Therefore, the role of communication is examined in this study.

Regarding the quality and quantity of alternative jobs available to the employee, when an
employee perceives few job alternatives, leaving is not a feasible action in case of a
psychological contract breach, and therefore perceiving a breach becomes threatening (Robinson
& Morrison, 2000). Conversely, when an employee perceives many job alternatives, (s)he will
experience the perception of a breach as less threatening (Robinson & Morrison, 2000). Turnley
and Feldman (1999) found that the availability of alternatives influences the relationship between
a psychological contract breach and employee responses. Employees who can easily find a
similar occupation elsewhere are more likely to experience negative responses to a breach than
employees who cannot. Therefore, perceiving few attractive job alternatives is likely to play a
role.

Studies so far have mainly focused on the consequences of psychological contract breach. Few
studies examined how changing organizations, where a breach is inevitable, can reduce or offset
the consequences of a psychological contract breach. Furthermore, most of the research on
psychological contracts are carried out using cross-sectional questionnaire surveys (Conway &
Briner, 2005), whereas the psychological contract is characterized by its dynamism, that is, by
changes in the reciprocal exchange. The dynamic processes after psychological contract breach
have been highlighted in conceptual and empirical studies (De Ruiter et al., 2016; Farnese et al.,
2018; Schalk et al., 2018; Schalk & Roe, 2007; Solinger et al., 2016; Tomprou et al., 2015).
Remediation as a dynamic process, however, has been neglected. The present study employs a
qualitative research design, which gives a deeper understanding of people’s perspectives and
does justice to the fact that social life is a contingent and emergent process (Hammersley, 2008).

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Question#4

What is organisational legitimacy? If an organisation’s management

considered that the organisation might not have operated in accordance with
community expectations (it broke the terms of the social contract), consistent
with Legitimacy Theory, what actions would you expect management to
undertake in the subsequent period? What do isomorphism and decoupling
mean with respect to their use in Institutional Theory? Why might an
organization decouple its actual internal process from those that it portrays to
the ‘outside world’? To what extent do Stakeholder, Legitimacy and
Institutional Theories provide competing, mutually exclusive, explanations of
voluntary corporate reporting practices?

Answer:
Organizational legitimacy is a central concept within organizational research. Most definitions of
organizational legitimacy refer to the appropriateness or alignment of a subject in the context of
a social system. Earlier examinations of legitimacy frequently considered a nation-state or an
organizational field as the social system of interest; later examinations have considered
communities, world society, and the individual as the social system conferring legitimacy. The
term “subjects” is used to refer to the many types of social arrangements under the umbrella of
the organizational legitimacy; subjects is used instead of objects because “subjects” grants at
least some level autonomy to the social arrangement or the actors involved and because
legitimacy is fundamentally subjective, not objective. Organizational legitimacy has been studied
for many subjects in addition to organizations themselves, including industries (such as
electricity generators), populations of organizations (such as newspapers), classes of
organizations (such as multinational enterprises), structures (such as the multidivisional form),
practices (such as downsizing and information technology), and even organizational leaders
(such as CEOs). Consideration of leaders and authority structures within organizations demarks a

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boundary between organizational legitimacy and legitimacy in groups, a topic in social
psychology that also has a large body of research.

The findings indicate that non-export oriented companies perceive responsibility to

community as a social obligation and organisations are accountable to the community as

they use the resources supplied by the community. However, export oriented manufacturing

and service companies disclose more of their CSER activities than non-export oriented

companies. This may be because export oriented companies from developing countries are

subject to pressure from international buyers to ensure their social and environmental

compliance (Islam and Deegan, 2008; Momin and Parker, 2013). Failure to comply with the

expectations of powerful international buyers may pose a legitimacy threat. Consistent with

this argument, Islam and Jain (2013) argue that in the era of globalisation, international

buyers outsourcing products from developing countries strongly emphasise human rights,

child labour and environmental issues and seek a greater level of disclosure in this regard.

Despite this, we argue that some disclosures, as evident from our interviewees with

managers, are morally driven rather than an impact of stakeholder pressures.

Several previous studies have provided a link between CSER reporting as a means

of organisations’ accountability to society at large within the context of developed countries

(Barnett, 2007; Carroll, 1979; Davis, 1983; Epstein, 1989; Lynes and Andrachuk, 2008;

Meehan et al., 2006; Shen, 2004; Van der Voort et al., 2009). Interviewees in this study

perceive that CSER reporting is growing and organisations in Bangladesh are adopting

social and community development agendas in their CSER reporting without influence from

stakeholder groups. These findings can be explained by both accountability theory and

legitimacy theory. Interviewees perceive that organisations in Bangladesh are undertaking

CSER and provide disclosures due to a sense of accountability to the society and

community in which they operate. This is consistent with the view of accountability theory

that organisations are accountable to stakeholders for all their actions including social and

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environmental issues based on obligation (Gray et al., 1996). The findings indicate that not

all obligation/responsibility driven CSER activities are reported through annual reports or

other forms of media as the organisations do not feel any pressure to disclose. The annual

reports of the companies reflect the minimum CSER reporting disclosures. Momin (2013)

argues that without regulatory measures or mandatory CSER reporting framework, CSER

reporting practices will remain minimal (Momin, 2013). In terms of legitimacy theory, the

findings of this study are consistent with the view that there is an implied contract between

society and an organisation. Therefore, it is vital for an organisation to fulfil society’s

expectations by undertaking social and environmental responsible actions. Moreover, the

legitimacy to society and stakeholders is crucial for organisations’ survival (de Villiers and

Alexander, 2014; de Villiers and Van Staden, 2006).

Institutional isomorphism was distinct from these perspectives in its assertion that organizations
became similar not through adaptation to an external or technically demanding environment or
through the “weeding out” of technical and social misfits, but through adaptation to a socially
constructed environment. When organizations are pressured to adapt to societal rationalized
myths about what organizations should look like and do, they face two problems: First, the
rationalized myths may not comprise an efficient solution for the organization, and second,
competing and mutually inconsistent rational myths can exist simultaneously. Meyer and Rowan
(1977) proposed that organizations decouple their practices from their formal or espoused
structure to solve these two problems of institutional pressures. In effect, decoupling means that
organizations abide only superficially by institutional pressure and adopt new structures without
necessarily implementing the related practices.

Public interest theoryThis theory holds that regulation is a public good that benefits society
(Posner, 1974).Government intervention is necessary to create a regulated reporting
environment,with the objective of ensuring that accurate accounting information about firms
issupplied to the market. This increases investor confidence in individual firms andimproves
overall market efficiency as a whole. Following various high-profile casesof accounting
manipulation and corporate collapses in the first years of the 2000s,the Sarbanes-Oxley Act of
2002 in the USA, the Corporate Law Economic ReformProgram (CLERP) 9 Act of 2004 in

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Australia and the mandatory application ofaccounting standards in Europe and Australia are
viewed as public interest regulatoryresponses. Also, the Financial Reporting Council in Australia
and the PublicCompany Accounting Oversight Board (PCAOB) in the USA have specific
objectivesand roles to serve the public interest. While public interest theory considers
thenormative or stewardship role of regulators, it ignores the opportunistic rolesof regulators,
capture of the regulatory process by regulates and the private interests ofother stakeholders.
Furthermore, the possible lack of competence by regulatorsand their being disinclined to protect
the public interest may reduce the potentialefficacy of this theory (Gaffikin, 2008).The capture
theoryThis theory challenges the assumptions of public interest theory. As accountingnumbers
are influenced by accounting standards, various actors may strive tomaximise their own interests
by lobbying the standards-setting process (Zeff, 2002; Hillet al., 2002). The standard setting
process in Australia has seen the powerful presence,preferences and lobbying by the elite
accounting profession and former executivesfrom large companies (Walker, 1987). Craig and
Clarke (1993) argue that Australianstandard setting was characterised by capture, control, co-
existence and coercion. Theinternational accounting standard setting process, while ostensibly
open andtransparent, also has the potential of being captured by powerful interest groups(Cortese
et al., 2009). The International Accounting Standards Board (IASB) at presentconsists of
members from the large accounting firms, executives from multinationalfirms and a few
mainstream accounting academics.A limitation of capture theory is its preoccupation with
influence and preferencesof those groups with the voting rights necessary to directly influence
the standardsetting process. In practice, non-members including professional accounting bodies,
big accounting firms and executives from multinational companies without votingrights can also
comment on exposure drafts (Tutticci et al., 1994; Jupe, 2000).To overcome the limitations of
both public interest theory and capture theory, theassumptions of private interest theory on the
basis of suggestions of Stigler (1971) andPosner (1974) allows a more comprehensive
understanding of the economic theory ofregulation. According to this theory, numerous private
interest groups are (in) directlyinvolved in the development and implementation of accounting
regulation, all of whichare self-utility maximisers.4. Stakeholder theoryStakeholder theory
asserts that the corporation’s continued existence requires thesupport of the stakeholders, their
approval must be sought and the activities ofthe corporation should be adjusted to gain that
approval. The more powerful the stakeholders, the more the company must adapt (Gray et al.,

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1995a). Literally, the definition of stakeholder has altered substantially over the past four
decades. At one end of the spectrum, the shareholder was considered the sole or principal
stakeholder. This definition is based on arguments proposed by Friedman (1962) thatthe
corporation’s foremost objective is to maximize the wealth of its owners (Friedman, 1962).
However, Freeman (1984) expands the definition of stakeholder to include broader selection of
constituents including adversarial groups such as interest groups and regulators. Both the narrow
(shareholder) and the expanded definition of stakeholders have been adopted in the development
of mandatory disclosure regulations for corporations (Roberts, 1992).According to Deana et al.
(2000), stakeholders have the ability to affect (directly or indirectly) the control of resources
required by the corporation. Thus, stakeholder power is determined by the level of control they
have over the resources. The stakeholder-corporation power relationship is not generic across
corporations (Deeganet al., 2000). According to Ullmann (1985, p. 552), power may take the
form of commandof limited resources (finances, labour), access to influential media, ability to
legislateagainst the company or ability to influence the consumption of the organisation’sgoods
and services. Therefore, when stakeholders control resources critical to theorganisation, the
company is likely to respond in a way that satisfies the demands ofthe stakeholders. Furthermore,
Ullmann (1985) argues that organisations select thestakeholders that they want/need to consider,
and the actions that they will take toachieve the desired relationship with those
stakeholders.Stakeholder theory is generally concerned with the way that an
organisationmanages its stakeholders (Gray et al., 1997, p. 333). As a result, Ullmann (1985)
arguesthat an organization’s strategic posture describes the mode of response of the
organization’s key decision makers towards social demands. Therefore, stakeholdertheory sees
the world from the perspective of management. Despite an extension beyond the economic and
an acknowledgement of power relationships between the corporation and its stakeholders, Gray
et al. (1997) argue that stakeholder theory is flawed because stakeholder theory focuses on the
way the corporation manages its stakeholders. The corporation identifies the stakeholders that it
will consider, and the level of attention it will give to each is based on how those stakeholders
can benefit the organization. According to Gray et al. (1997), stakeholder theory is essentially a
market forces approach in which resources and the provision/withdrawal of those resources
determine the type of the voluntary social disclosures ata given point in time. In addition, they
argue that the organisation centered on which stakeholder theory is reliant ignores important

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influences of society as awhile on the organizations’ provision of information. These include the
existence of statute law and regulations developed by government and statutory bodies, which
contain requirements for information disclosure (Gray et al., 1997).The voluntary disclosure
literature is interlinked with the literature on corporate governance and the literature on
management incentives. Each of these literatures hasendogeneity problems, and there is
uncertainty and active debate on how to measure governance quality and how to measure
incentives. Core (2001) reveals many contributions that can be made to the voluntary disclosure.
A major contribution can be made to the voluntary disclosure literature by establishing how
information asymmetry affects the cost of capital, and in particular determining whether
information asymmetry affects expected returns. A second contribution can be made by creating
more precise measures of the information asymmetry component of the cost of capital. A final
contribution can be made by using computer technology to lower the cost of computing
disclosure quality indices. These measures would add power to most disclosure-related research
designs, as well as help address more general issues of fundamental interest to accounting
researchers.5. Legitimacy theoryDowling and Pfeffer (1975) suggest that legitimacy theory is
useful in analysingcorporate behavior. Because legitimacy is important to organisations,
constraints imposed by social norms and values and reactions to such constraints provide a focus
foranalysing organisational behaviors taken with respect to the environment (Dowlingand
Pfeffer, 1975, p. 131). Gray et al. (1995b) argue that legitimacy theory and stakeholder theory
should be seen as overlapping, as opposed to competing theories. They explain that both
perspectives are set within the framework of PET. As the influence of society as a whole can
affect the provision of financial and other resources to the firm, the firmutilises environmental
performance and disclosure to justify or legitimize its activities to society (Gray et al., 1995a, b).
According to Deegan (2002), understanding motivations for disclosure is shown to be one of the
issues attracting considerable research attention, andthe desire to legitimize an organization’s
operations is in turn shown to be one of them any possible motivations. He also discusses the
role of legitimacy theory in explaining managers’ decisions and emphasizes that legitimacy
theory must still be considered tobe a relatively under-developed theory of managerial behavior.
Nevertheless, he argues that legitimacy theory provides useful insights. Deegan (2002) also
indicates how the other researchers can contribute to the ongoing development of legitimacy
theory in social and environmental reporting research.

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Question#5

What do you mean by ‘market efficiency’? If some research is undertaken

that provides evidence that capital markets do not always behave in
accordance with the Efficient Markets Hypothesis, does this invalidate
research that adopts an assumption that capital markets are efficient?
Explain what is meant when we say that the information content associated
with unexpected earnings (profits) announcements is expected to be inversely
associated with the size of an organisation. Would you expect an earnings
announcement by one firm within an industry to impact on the share prices of
other firms in the industry? Why or why not?

Answer:
Market efficiency does not require that the market price be equal to true value at every point in
time. All it requires is that errors in the market price be unbiased, i.e., that prices can be greater
than or less than true value, as long as these deviations are random. The fact that the deviations
from true value are random implies, in a rough sense, that there is an equal chance that stocks are
under or over valued at any point in time, and that these deviations are uncorrelated with any
observable variable. For instance, in an efficient market, stocks with lower PE ratios should be
no more or less likely to undervalue than stocks with high PE ratios.

There could be various reasons why the share price did not change. Perhaps there was other
information released on the day that offset the effects of the specific information, or perhaps the
assumptions of market efficiency do not hold. The other point that must be made is that share
price studies only consider the reactions of one group of stakeholders—investors. Particular
information might be relevant to other parties who do not directly participate in the capital
market, but have a right to know about particular information. Hence, failure to find a share price
reaction does not mean that information is necessarily irrelevant to all stakeholders.

Yes, I expect to expect an earnings announcement by one firm within an Industry to impact on
the share prices of other firms in the industry. Existing research suggests that the annual report

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readability may be the result of intentional management manipulation, which represents poor
earnings quality (Li, 2008; Li & Zhang, 2015; Lo et al., 2017). On the other hand, the poor
readability makes it difficult for investors to understand the information, leading to insufficient
market response to annual report (Lee, 2012; Lehavy et al., 2011). Therefore, the indexes above
are tested from these two perspectives. This result implies that investors cannot timely
understand the information with poor readability, so the stock price reflects the annual report
information slowly over a long period. Taking Fog Index and text length as the proxy variables
of readability, Lee (2012) continues this work and directly tests the impact of the quarterly report
readability on market efficiency. She suggests that a more readable quarterly report can facilitate
investors' understanding, so that the earnings information can enter the stock price faster and
reduce the stock price drift after earnings announcement.

Landsman and Maydew (2002) posit that the information content of the announcements such as
annual reports and quarterly earnings report has increased exponentially leading to an increased
investor reaction. Researchers have concluded that the concise disclosures in audit reports
resulted in investor reaction based on whether the information is perceived as positive or
negative by institutional and sophisticated investors (Holthausen & Verrecchia, 1990;Kaplan,
Mowchan, & Weisbrod, 2014;Lee, 2012;Menon & Williams, 2010;Miller, 2010). Further, report
readability also affects investors' processing fluency, a subjective feeling about how much
weight individuals will place on the disclosure in their decision making. Consistent empirical
evidence corroborates these propositions, indicating that investors underreact to bad news when
it is disclosed in a more difficult-to-read manner ( Bushee et al., 2017;Hooghiemstra et al.,
2017;Lee, 2012;Li, 2008;Libby and Emett, 2014;Miller, 2010) and investors' judgments rely
more heavily on the disclosure when information is disclosed with greater readability (Shah and
Oppenheimer, 2007;Rennekamp, 2012).

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