AF301

Topic 8
Systems Oriented Theories
Learning Outcomes
On successful completion of this unit, you should be
able to

1. Outline systems-based theories

2. Apply and critique the two branches of stakeholder
theory
3. Apply and critique legitimacy theory
4. Apply and critique institutional theory
LO 1

SYSTEMS-BASED THEORIES
Overview
These theories examine entities as part of a broader
social system
 Entities are affected or influenced by the society in
which they operate e.g. through inputs, values etc.
 Entities also affect/influence society e.g. through
positive and negative externalities
Accounting disclosure (particularly voluntary disclosure)
provides a means
 to influence or manage relationships;
 between an organisation and other parties which
it interacts with
LO 2

STAKEHOLDER THEORY
Stakeholders
A stakeholder is any group or individual who
 can affect; or
 is affected by
achievement of the firms objective(s) (Freeman 1984)

This term is much broader than shareholders

 who are the traditional focus of financial reports
 In general, shareholders primarily provide
financial inputs and expect financial returns
Main Stakeholder Relationships
Group Provide Rely on organisations for
Investors Finance Returns e.g. dividends
Lenders Finance Returns e.g. interest
Customers Revenue Products and Services
Employees Labour Employment and Income
Suppliers Inputs Market for their own goods
and services
Government Subsidies, Investment, tax revenue
Infrastructure etc.
Stakeholders’ Influence
Stakeholders can constrain or limit the strategies that
managers can adopt
This influence is based on one or more of the following:
1. Command of limited resources e.g. finance
2. Ability to influence consumption of an
organisation’s goods and services e.g. customers
3. Access to influential media including social media
4. Ability to legislate against the company e.g.
government
Managerial (Positive) Branch
This is a positive theory
 It explains and predicts managerial actions
In general, managers give greater priority to the needs
of more powerful stakeholders
 Power depends on stakeholder influence
This theory is reflected in voluntary corporate
disclosure
 Firms disclose information that’s demanded by
powerful stakeholders, even though there is no
mandatory requirement to do so.
Ethical (Normative) Branch
This is a normative theory
 It prescribes the actions that managers should
take.
In general, managers should manage the business for
the benefit of all stakeholders
 giving equal priority to the needs of all
stakeholders
This theory may also be reflected in voluntary disclosure
 to a broad range of stakeholders
 affirming their intrinsic right to information
Critique of Stakeholder Theory
1. Managerial branch fails to consider ethical issues
and implications
 It emphasises the business case in every decision
i.e. benefits of disclosure must exceed the costs
 No moral judgement is exercised
2. Normative branch may be unrealistic in the sense
that organisations
 face resource constraints, including cost to obtain
and disclose information; and
 may struggle to respond to every stakeholder
(impractical to satisfy every information need)
LO 3

LEGITIMACY THEORY
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Rights of entities
Under legitimacy theory, entities have no inherent right
to use resources
 this right is conveyed by society through the social
contract
 the right can be revoked

Society expects that an entity will

 produce social benefits
 exceeding social costs e.g. pollution
Social Contract
1. This contract is generally unwritten i.e. implicit
 Some terms may be explicit e.g. legislation

2. It is based on societal norms and values i.e. what

society views as acceptable. They
 could be fluid i.e. change over time
 may differ across societies, countries etc.
Legitimacy
Organisations obtain legitimacy by behaving and
operating within the terms of the social contract
 The entity’s actions are congruent or aligned with
society’s expectations.

A ‘legitimacy gap’ means the entity’s actions have

diverged from society’s expectations. In such cases,
 Customers may boycott the entity, the community
may protest etc.
 Entities risk revocation of their ‘license to operate’
Legitimising Activities
An entity can use voluntary disclosure to Highlight good news
1.Educate and inform the community about how it has
actually changed its performance and activities.
2.Manipulate perception by deflecting attention from
issues of concern to another issue. Ignore bad news

3.Try to change perceptions, without changing is

behaviour e.g. employing symbols which are regarded
as legitimate. Seen as good by association

4.Try to alter societal expectations in line with entity’s

behaviour eg. Demonstrating that societal expectations
are unreasonable. Not relevant/appropriate etc.
Legitimising Activities

What messages can you identify in this advertisement?

Types of Legitimisation
Type Through these activities …
Complementary Both the entity and its products are
perceived as good e.g. Rural, SMS or
internet banking
Neutral The entity (but not its products) is
perceived as good e.g. corporate
donations following natural disasters
Perverse The entity is perceived as good
although its products are harmful
e.g. alcohol producers sponsoring
sports tournaments
Critique of Legitimacy Theory
1. It adopts a very narrow view of an entity’s motivations
 all actions are assumed to be based on legitimacy
e.g. even a donation is regarded as having an ulterior
motive (rather than humanitarian).
2. The terms of the social contract are not clearly stated
or known because it is unwritten.
 How often do we see a firm’s social contract being
revoked? i.e. does it work in reality?
3. It assumes that society is homogenous i.e. everyone
thinks alike and shares the same values. This may not
always be the case.
LO 4

INSTITUTIONAL THEORY
Institutional Theory
This provides a complementary perspective to
stakeholder and legitimacy theory
One of the main concepts in this theory is isomorphism
(three types) meaning that:
 Organisations tend to adopt similar characteristics
and form
 within an organisational field e.g. all firms in
the petroleum industry, banking industry
In this way, they conform to expectations, to be
perceived as legitimate
Coercive Isomorphism
Firms adopt the same practices due to pressure from
powerful stakeholders, which they depend on e.g.
 Commercial banks are likely to note and follow
comments by the Reserve Bank
 Companies operating under license e.g.
telecommunication, media are likely to note and
observe “suggestions” by government
This type of isomorphism is similar to the managerial
branch of stakeholder theory
Mimetic Isomorphism
When faced with uncertainty, firms copy or improve
practices of other firms in the industry e.g.
 new entrants to the market copy leaders and
more established firms
 Commercial banks may adopt the Equator
Principles if their competitors have done so
 Newer universities may copy USP’s courses
Normative Isomorphism
Firms adopt similar policies that reflect the norms of
professionals and professional organisations
 This is more common in organisations which rely
on academic credentials in selecting managerial
and staff personnel
 e.g. Accounting profession and accounting
standards or other guidance provided by the
accounting profession
Decoupling
This is not a type of isomorphism

Decoupling means that firms outward characteristics

may appear the same
 Use the right symbols e.g. adopt the same policies
or have the same departments etc.
However, a firm’s actual behaviour and performance
could differ from what it states publicly
 i.e. corporate image is disconnected or
‘decoupled’ from underlying reality
Summary
Theory Underlying concepts
Stakeholder  Managerial branch (positive) is related
to stakeholders’ power/influence
 Ethical (normative) branch assumes
stakeholders intrinsic ‘right to know’
Legitimacy Social contract conveys license to operate
Legitimacy gaps must be bridged
Institutional  Isomorphic pressure produces
similarity (coercive, mimetic,
normative)
 Decoupling (image is disconnected
from reality)
 AF301

Topic 8
Systems Oriented Theories