the influences of organizational structures

Tutorial 2

1. How might institutional theory explain accounting disclosures?

Institutional theory is used to understand the influences of organizational structures such as rules, norms and guidelines. Accounting disclosures are likely to be a way of demonstrating corporate legitimacy by disclosing how the organization is meeting the expectations of these rules, norms and guidelines.

2. What is a social contract and how does it relate to organisational legitimacy?

A social contract is used to describe how business interacts with society. It relates to the explicit and implicit expectations society has about how businesses should act to ensure they survive into the future. A social contract is not necessarily a written agreement, but is what we understand society expects. While the relationship between society and business is explained by the social contract, organizational legitimacy describes the state in which an organization has met the terms of the social contract. It explains the process by which the terms of a social contract is gained or maintained.

3. How can corporate disclosure policy be used to maintain or regain organisational legitimacy?

Four ways an organization can obtain or maintain legitimacy have been identified in the academic literature:

1. Seek to educate and inform society about actual changes in the organisation’s performance and activities
2. Seek to change the perceptions of society, but not actually change behavior
3. Seek to manipulate perception by deflecting attention from the issue of concern to other related issues
4. Seek to change expectations of its performance

Disclosure can be used as a technique in each of these strategies. An entity might provide information to offset negative news that may be publicly available. They could also use disclosure to draw attention to strengths or to down play information about negative activities. Disclosure can also be used to advertise actual changes in performance or activities.

4. There are two branches of stakeholder theory. How do they differ?

The two versions of stakeholder theory are: a normative theory, known as the ‘ethical branch’ and an empirical theory of management. The normative branch of stakeholder theory relates to the ethical or moral treatment of organizational stakeholders. It is argued that organization should treat all stakeholders fairly, and the organization should be managed for the benefit of all stakeholders.

The managerial branch of stakeholder theory is a positive theory that seeks to explain how stakeholders might influence organizational action. Rather than considering each stakeholder as equal (as is the case under the normative branch), the managerial branch proposes that the extent to which an organization will consider its stakeholders is related to the power or influence of those stakeholders, with executives managing these competing interests.

5. How can positive accounting theory explain corporate social and environmental reporting?

Positive accounting theory highlights the importance of minimising information asymmetry between owners and managers. Managers need to be mindful of presenting both good and bad news about the entity as it impacts on reputation and future share values. As such they are likely to provide information about social and environmental performance to ‘bond’ themselves to shareholder expectations regarding sustainability performance, and to reduce information asymmetry, thus leading to a reduction in the cost of capital.

6. The standard-setting process is highly political. Describe an accounting regulation that would be politically controversial, and the types of political pressures that could be brought to bear in the standard-setting process.

Students might choose any accounting issue as long as they can explain why it is political in the sense of affecting the wealth of parties in the political process.

Legislating for accounting standards reduces the outcomes to one of the political trade-offs of competing interests. The political process, as identified by Watts & Zimmerman (1978), involves competition for wealth distributions between different interest groups. In the accounting arena it involves politicians who have incentives to increase government resources and retain their political positions; companies who have an incentive to avoid political costs, such as increased taxes or regulations; and voters whose participation in the political process is a function of the cost of interpreting and processing vast amounts of information. Managers have incentives to adopt procedures that would decrease the political sensitivity of reported earnings and/or increase their personal wealth.

There are many groups who will lobby in the standard-setting process for preferred outcomes. The groups include trade unions, financial institutions, analysts and social groups. Individuals also lobby in the process.

Overall, the political process is seen as a means of pursuing individual or group self-interest (Watts & Zimmerman, 1979).

Some ways in which organisations have lobbied to affect the requirements of an accounting standard include:

• writing responses to exposure drafts
• writing to members of the accounting standard boards putting forward their views
• making oral presentations to the boards, or to individual members of the boards
• holding meetings where key issues are discussed and ensuring that members of the accounting standard boards are invited, or get to hear of the meetings
• holding demonstrations against a proposal that they do not favour — as occurred in Silicon Valley where executives demonstrated against proposals for accounting for executive stock options
• releasing media releases expressing their disagreement with proposed accounting regulation; these releases would then result in articles in the media or announcements over the news
• forming groups to lobby for using any or all of the above methods
• offering to provide funding to the regulatory bodies for an accounting standard that suits them.

The lobbying may also be indirect and framed in a manner that draws attention away from the direct benefits of those lobbying.

7. How do you think accounting standards should be set? Is that the approach currently taken by the IASB?

Here is one possible answer. The most feasible way may be to be aware of both the politics of the environment and the significance of scientific evidence in the formulation and implementation of standards. Where there is substantial theoretical and empirical evidence in support of a proposal, the IASB should be resolute in seeking to establish the standard. But presently such strong support does not occur often.

The fact is that pressing issues need to be resolved immediately, and there may be little, if any, empirical evidence pointing to any particular direction. In such cases, the IASB needs to follow a theoretical (rational) argument, based on the objective of providing more useful information.

There is no question that the IASB needs to be politically aware. However, to be aware of the political environment means different things to different people. If it means to do a better marketing job of explaining to all interested groups why a given proposal is being made, then that is acceptable. To receive and be aware of the points of view of various groups of a proposal should be helpful to the IASB because the proposed standard may not be as rational as the IASB believes. The due process procedure should be taken seriously and not be a perfunctory routine. Contrary arguments may have salient, legitimate points.

The IASB does attempt to be independent in the formulation of accounting standards. Because the support of its standards is mainly theoretical (based on rational arguments), and interpretation of theory can result in different viewpoints, strong opposition is seriously considered and is likely to cause a change in the proposed standard. Empirical evidence is considered. However, that the evidence is often not persuasive; perhaps because it is not understood by the non-academic community.

With the adoption of international financial reporting standards (IFRS), it has been suggested that the AASB and Australian constituents will have less influence over the IASB due process than was possible in the domestic standard setting environment. The AASB has a specific strategy of contributing to standard setting at the IASB to maintain its influence.

8. Each of the three theories of regulation discussed in this chapter has its strengths and limitations in describing accounting standard setting, either past or present. What do you believe are those strengths and weaknesses? Provide an example of where you believe each of the theories has applied, or is likely to apply.

Three theories of regulation are outlined in the text:

• Public-interest theory Legislation is intended to protect consumer interests by securing improved performance when compared with an unregulated situation. This assumes that there is market failure and consequently some groups will need to be protected from the opportunistic behaviour of others.

If there is a market failure and the legislation can redress the failure’s impact then the public interest will be served. However, this assumes that the legislation will redress the failure and not introduce alternative forms of market failure. It ignores the fact that equity will often be a matter of viewpoint, and legislation is often the outcome of a complex lobbying process. Further, the theory assumes that the regulators do not have their own interest set.

• Private-interest theory  Private-interest theorists believe that there is a market for regulation with supply and demand forces operating as in the capital market. Within this political market, while there are many bidders, only one group will be successful, and that is the group that makes the highest bid. Theorists believe that regulation does not come into existence as a result of a government’s response to public demands, but rather (as a rule) regulation is sought by the producer private-interest group and is designed and operated primarily for its benefit.

But even if a group has a strong incentive to organise, there must still be a mechanism by which the group acquires and uses its influence. It also assumes that players are always seeking to maximise their wealth.

• Regulatory capture theory  This theory argues that those who are regulated have an incentive to dominate the process, or in some way manipulate it to their advantage. Four such situations have been identified:

• where the regulated entities control the regulation and the regulatory agency
• where the regulated entities succeed in coordinating the regulatory body’s activities, so that their private interest is satisfied
• where the regulated entities manage to neutralise or insure non-performance by the regulating body
• where the regulated entities use a subtle process of interaction with the regulators to ensure a mutual perspective.

The concept assumes that the parties subject to regulation can form into a group or subgroup capable of capturing the process. In addition, capture will normally become apparent to observers in the community.

Contemporary issue 5.2

Power and duty: is the social contract in medicine still relevant?

Questions

1. What is a ‘social contract’?
2. The article discusses some of the implied terms of the social contract between doctors and patients. Articulate what these are and discuss how they are currently under threat.

1. The term ‘social contract’ has often been used to describe how business interacts with society. It relates to the explicit and implicit expectations society has about how entities should act to ensure they survive into the future. A social contract is not necessarily a written agreement, but is what we understand society expects of entities. Some expectations could be explicit (legislation relating to pollution or employee health and safety are examples), while others are implicit. Evidence of implicit terms of the social contract can be gained from communications and writing of a society at a point in time. Media attention to high executive bonus payments when share prices are declining could be an example of the degree of public importance placed on these issues, and therefore an implied component of a social contract.

2. Training doctors requires significant public investment, including through publicly funded universities and medical facilities. It was proposed in 2008 that the cost of training one doctor was approximately $1 million. As a result of this public investment, doctors are expected to serve the health needs of the community with ‘competent, ethical and professional care’.

There are a number of ways this social contract appears to be under threat. The corporatisation of healthcare, with a move towards private medical facilities operated for profit. This does not align with the ‘social contract’ view of a commitment to universally accessible publicly available funded health care. In addition there is the view that medical benefits scheme funding is often misused, which undermines public trust in doctors. This means that both the medical profession and doctors could be placing self-interest and financial concerns above the ‘common good’.