Importance of Social Contract in the Theory of Legitimacy (In Accounting Field)

Now business organizations are doing voluntarily disclosure of their non financial information with financial information. Now they are showing their social performance, ecological performance and political performance voluntarily to their stakeholders. According to theory of legitimacy, it is the responsibility of the organization to provide information to the society where they operates their operations.

Application of social contract in theory of legitimacy defines the responsibility of the organization towards the society. Organization is bounded by the contract with the society. By fulfilling the expectation of society, society gives permission to them to perform their activities without the interference of anybody (Etzion and Ferraro, 2010). Now days, application of social contract to the theory of legitimacy in accounting provides satisfaction to the stakeholders of organization that they are performing their activities without harming the environment and interest of stakeholders.

Social contract is the contract which exists between Society and the organization. There are two forms of social contract; first form of social contract is implicit whereas another form of social contract is explicit. Firstly, in literature review assignment we will discuss the Importance of social contract in the theory of legitimacy (In Accounting Field), after that Evolution of Theory of social contract, Voluntarily disclosure of non financial information by business entities, Organization acting legitimately for application of social contract, Implication, if organization fails to disclose Non financial information, then at last we will Comparing theory of Legitimacy with Institutional theory, stakeholders theory and theory of positive accounting with respect to accounting and conclude the same. 

Purpose of existence of social contract between organization & society is to protect interest of the individuals, bring equality and transparency in the reporting system of organization. It also helps in the development of society. Social contracts plays very vital role in application of theory of legitimacy in business organization’s reporting system. In today’s world it becomes important to fulfill the demand of society. If business organization wants to work without any interference then it has to work by meeting the needs and demands of its stakeholders. This could be achieved by applying the concept of social contract to legitimacy theory. Hobbes had contributed for the development of social contract.

Increasing disclosure requirement of the business entities have positive impact upon the entity. Business organization should provide surety to its stakeholders that they are complying with the rules and the regulation which are imposed upon them. Organization has right to select target audience which would become the part for the disclosure of the business organization. Media will favor the business organization if business organizations are voluntarily disclosing their non financial performance in their annual report. Reporting by business organization regarding their non financial information can be assumed as the responsibility of the business organization rather than demand. Theory of legitimacy is based upon the notion of social contract. During earlier period, organization only discloses their financial information (Lang, 1991).

Reasons for Sustainability Accounting and Reporting

 At that time, profit maximization was  main aim of the  organization. But, with the increase in importance of social contract, it becomes important to consider the interest of society as well. Now company’s main objective are: profit maximization, fulfilling the need of society, protect the interest of stakeholders, bring equality in the society. It all happens because of application of social contract to theory of legitimacy with respect to accounting.

– Pressure from industry for sustainable accounting and reporting.

– Green washing is another reason for sustainable accounting and reporting.

– Self regulation- Voluntarily disclosure of environmental & social issue to maintain the reputation in the society and get competitive edge in the market.

– Pressure from stakeholder for sustainable accounting and reporting.

– Ethical reasons & corporate social responsibility, is another reason for sustainable accounting and reporting. 

Hobbes (1985) has contributed for the development of theory of social contract. He explained that both the term legitimacy and legitimating are different. Legitimacy can be explained as the situation that exists when organization will fulfill the needs of its stakeholder whereas legitimating can be explained as the ability of entity to be seen as legitimate. O’dwyer, Jeffrey and Hession (2005) explained “legitimacy theory from perspective of stakeholders”. With the help of questionnaire, they read the point view of stakeholder regarding Sustainability accounting and reporting (social issue and environmental issue), they concluded that for stakeholder sustainable reporting is important because it helps them to take decision appropriately. Paulo (2009) analyzed the development of social contract in accounting field of organization.

He took the sample of one hundred and thirty six companies to know the sustainability reporting provided by the business organizations. He concluded those big firms are providing more sustainable reporting as compared to small and medium companies.

Etzion and Ferraro (2010) conducted study upon analogy’s role in legitimacy theory (with respect to social contract). They studied that contribution of Global reporting initiative (GRI) for sustainable accounting and reporting. They concluded that: during early period of institulisation, analogy will perform their activities as a normative mechanism. According to Vogt (2000), hypothesis of Legitimacy is utilized for “exposure necessity of business element regarding social issues in yearly report changed with the progression of time”. He clarified that hypothesis of authenticity depends on certainty that social contract ought to exists between organization element & society.

Social contract clarified the express & verifiable perspectives and society’s desire from organization substance. Gordon and Deegan (1996) concluded that disclosure requirement has favorable impact on business enterprise. It enhances the connection amongst association and society.

Evolution and Development of Theory of Social Contract with Respect to Theory of Legitimacy

Patten (1992) clarified if there was change in exposure necessity of US oil factories which is located in Alaska. According to Legitimacy hypothesis there is increment in the revelation necessity of oil factories, which causes increment in general exposure prerequisite of the business.  Shirley (2010), conducted study on Sustainability reporting by small & medium scale companies in field of electricity in Australia. He analyzed the reporting by small & medium scale companies in the field of electricity in Australia & finds the possibility for alliance between company, government & industry to which such company belongs.

He concluded that very few companies provide sustainability accounting and reporting in the field of electricity in Australia. Thus, there is need to encourage the companies to provide sustainability reporting (reporting regarding non financial performance of business organization). 

Hobbes (1985) developed a theory which is based upon the notion of social contract. Social contract can be defined as a contract between organization & the society where organization has to fulfill the expectation of its stakeholders while doing its activities. There are two angles of social contract; one is implicit desire of society from business organization whereas another is explicit desire of society from business organization. Existence of social contract between business organization and business entity is very important for society’s development. There should sustainability reporting by the business organization.  There is need to encourage the companies to provide sustainability reporting. 

If organizations do voluntarily disclosure of its social performance and social performance then it will provide an edge to the business organization over its competitor. Sustainability reporting is necessary for the development of the society as a whole because in modern era it is very important to consider environmental issue and social issue. In 1970’s green movement was undertaken to promote environmental accounting in business organization. Triple bottom line reporting should be followed by business organization.

Deliberate corporate social introduction are creatively interceded talks which pass on a “domain of believably” and are depended on by relevant open as delineations of honest to goodness exercises, yields and focuses as these were not quickly noticeable. Intentionally disclosure chooses, resonate and redesign winning societal focuses and qualities. All the affiliation purposely uncovers “social” information in yearly report. Willfully disclosures can show up as organization exchange in yearly reports of association/separate disclosure.

Chung (1996) stated that worldwide specifying action which is generally called Global announcing activity showed up in 1997.Business organization provides sustainable reporting, because sometimes management of the business organization is interested towards sustainable reporting.

Social Contract Between Society and Business Organization

The reason behind sustainable reporting is to gain an edge over the competitor and to reduce intervention of government in the operation of business organization (Perera, Chowdhury and Goswami, 2007). 

These days sustainability accounting and reporting has become very popular in many countries. Now business organization has to report regarding sustainable performance of the organization (Ashley and Carney, 1999). Sustainability development measure the performance of the company on the basis of three aspects: one is, environmental, second one is social and last one is economical.

It has positive impact upon the business organization. It brings transparency in the system. Sustainable development helps in development of society as whole. Now a day it is very important to consider non financial issue (social issue, environmental issue). Business organization has to achieve its financial objectives by fulfilling the expectation of society from the business organization. If organization does sustainable accounting and reporting voluntarily then it provide competitive edge to the business organization over its competitor. It increases the reputation of business organization in the society and it reduces the intervention of government in business operation of the business organization. Sustainable development goals have positive impact upon business accounting and reporting (O’dwyer, Jeffrey & Hession, 2005). 

Associations are changing divulgence arrangement, now organizations are indicating social issue, ecological issue & political issue with respect to the execution of the organization. In the event that association will act honestly then naturally it will accomplish its objective adequately and effectively, it gives edge to association over its rival. In today’s era, application of sustainable accounting and reporting in business organization plays vital role as it provides satisfaction to the stakeholders that   actions of entities are desirable   &appropriate without harming the interest of stakeholders (Treasury, 2010). 

According to Ray Anderson, business sustainability can be defined as “human capital of the business organization should be managed in such a way in which financial capital of the organization is managed “.Stakeholders of the business organization have complete right to know about the financial as well as non financial performance of the business organization. Because they have to take the decision, for decision making of stakeholders, company should disclose sustainable activities of the business organization

For some companies, sustainable reporting increases their market value & long term profitability. Sustainability reporting includes reporting regarding social issue & environmental issue. There are so many factors which indicate that sustainable reporting is emerging with changing in time. One of the prime factors is “direct involvement of accounting firms”. Sustainable accounting and reporting helps their firm to expand their business and provides an edge over their competitor (Ruud, 2003).

Voluntarily Disclosure of Non-Financial Information by Business Entities

There are no standards upon sustainable accounting and reporting. For example: GAAP (general accepted accounted principles) provides standard for accounting of financial information of the organization. But there is no standard for sustainable reporting.

Global reporting initiative (it is also known as GRI) was established in 1997, it is an independent institution which provides guidelines and framework for sustainable accounting and reporting by business organization (Ball, 2002). There are around six hundred and sixty five companies which work according to the framework provided by Global reporting initiative. Sustainability accounting and reporting brings transparency in the system of accounting and reporting. It ensures that interest of the stakeholders should be considered by business organization while performing their operation. 

Endeavor ought to act honestly by giving data to the general public and by satisfying their desire. On the off chance that association will act genuinely then naturally it will accomplish its objective adequately and proficiently, it gives preferred standpoint to the association over its rival (Lang, 1991). Associations are changing revelation strategy, now entities are indicating social issue, natural issue & political issue with respect to the execution of the organization. In today’s time, utilization of contract (social) to authenticity hypothesis in bookkeeping assumes a vital part as it give fulfillment that associations’ activities are proper and attractive without hurting the enthusiasm of the general public (Shank,2005).

Entity substance gives confirmation to society which is conforming to the desire of society. Contract (social) speaks to the desire (verifiable and express) of society regarding “how business element ought to play out its activities”. Contract (social) is vital for authenticity in bookkeeping. At the point when partner request that the business element give the data with respect to the execution of organization, then in organizations substance can’t deny to partner, organization is limited to give vital data to the partner. Data which is given by organization can be expected as a “duty” of business association. A business association can choose the gathering of people which will turn out to be a piece of such exposures. It winds up noticeably critical for business venture to consider request of society when performing their exercises. 

Fundamentally, legitimacy theory, positive accounting theory and stakeholder theory are depended upon the specific framework. The prime thought process of speculations is unveiling connection between business substance and society concerning exposure of non monetary data. The association has impact upon the general public where they work their exercises and society additionally has impact upon business substance. Theory of legitimacy& stakeholder theory depends on Political bookkeeping theory.

Organization Acting Legitimately for Application of Social Contract

Structure for social, political, and issues related to economics is given by political theory. Business element won’t have the capacity to report in regards to financial without political theory. Under this hypothesis, revealing which is finished by big business is with respect to products which are traded among condition and business substance. Political hypothesis can be subdivided into parts. Initial segment is called traditional perspective while second part is known as Bourgeois. The point of traditional piece of political theory is to limit clashes in the public eye. As per Friedman (1970)

– Social revelation (announcing) by association conveys straightforwardness regarding non accessibility of assets. Another piece of political theory monetary does not offer thoughtfulness regarding society’s contentions. The point of middle class some portion of political theory is to break down cooperation of association with the general public. Both legitimacy theory and stakeholder’s theory are set up from common part of hypothesis of political monetary. There are 2 branches of Stakeholder hypothesis. First branch is called moral branch (likewise regulating branch).Second branch is called positive branch (likewise administrative branch).

 Stakeholders could be characterized as gathering of people who have affect upon business substance & the other way around additionally apply. Stakeholder’s advantage is associated with substance as they are associated with element. The primary point of this hypothesis is advancing enthusiasm of people (stakeholders) and evades clashes between stakeholders and association. There are two sorts of stakeholders, Primary Stakeholder of association and secondary stakeholder of association (Shirley, 2010). 

Primary stakeholder’s illustrations are: representatives of associations and administration of associations. Secondary stakeholder (as indicated by Reed), does not meddle in every day exercises of association. Secondary stakeholders are not occupied with day by day exercises of association but rather Secondary shareholder can have affect on association. Auxiliary shareholder of entity substance could be affected from operations of element & business element could likewise be impacted from the secondary shareholder.

An auxiliary partner case is: shareholders. Association’s partners don’t meddle in day by day exercises of substance yet elements of element have an effect upon shareholders and the other way around additionally connected. As indicated by stakeholder theory, Stakeholders of the organization have legitimate ideal to acquire money related and also non monetary data from big business concerning their execution. On the off chance that Stakeholders of the organization request that the association give budgetary and non monetary data as for execution of the organization, then association ought to need to gave give money related and in addition non monetary data as for execution of the organization. Data given by business association is the “obligation” of substance (Ball, 2002).

Implications of Not Disclosing Non-Financial Information

They can’t deny to partner since it is the obligation of the element to give significant data. The administrative branch which exists for partners broke down “whether substance is playing out its exercises as indicated by partner’s desires.

Under stakeholder theory, business element just considers specific gathering just though in principle of authenticity, society as entire (finish) is taken by the association. Hypothesis of Stakeholder has limit scope while legitimacy theory has more extensive degree. The purpose for this is legitimacy theory takes society as entire however stakeholder theory considers “certain gathering of people”. Hence, it could be reasoned that legitimacy theory covers stakeholder theory, other than both legitimacy theory and theory of stakeholder are built up from positive accounting theory. Stakeholder theory comprises two sections; initial segment is “moral” and the second part is administrative. Business association’s administration is directed by moral viewpoint and administrative part of hypothesis of partner.

Here and there, hypothesis of positive bookkeeping has examination with hypothesis of Legitimacy. Contract (social) gives establishment regard to hypothesis of authenticity. Hypothesis of Legitimacy does not base upon the suspicions (primarily suppositions with respect to economic).As per the presumptions in light of monetary, all actualities are managed by amplification of benefit yet hypothesis of positive bookkeeping is depended upon specific standards). It could be reasoned that legitimacy theory is more extensive as for terms and it likewise gives finish perspective of association though theory of positive accounting is thin regarding terms and it doesn’t gives finish perspective of association (Chung,1996).

Variables which are not cost are overlooked by Positive theory bookkeeping though these components (non-cost) are considered by hypothesis of Legitimacy, so that association can work its exercises by satisfying society’s desire and need. Hypothesis of Legitimacy got straightforwardness business association’s framework. One might say that hypothesis of Legitimacy covered hypothesis of positive bookkeeping. Institutional theory gives linkage among practices of substances and social esteems.

In principle of institutional hypothesis, association is more disposed towards consistency. Institutional hypothesis has 2 sections. Isomorphism is initial segment and decoupling is second some portion of institutional hypothesis. Isomorphism part of hypothesis of institutional can be clarified as the procedure which limits energy of one fragment in the public arena to match adjusting sections which confronts same sort of normal (natural) issues( Ashley and Carney, 1999). In isomorphic viewpoint (institutional hypothesis), there are three procedures.

First perspective is “coercive”, second angle is “mimetic” and “regulating” is third angle. Coercive is a procedure which is same as administrative part of hypothesis of partner hypothesis. Under coercive process (isomorphism), association changes its day by day hone on account of the weight put by partner upon big business. Solid Stakeholders have desire from unmistakable substance also. In isomorphism’s mimetic procedure, business substance takes applicable thoughts from contender to get advantage over the contender and this will lessens chance as for instability in element.

Comparing Theory of Legitimacy with Institutional Theory, Stakeholders Theory and Theory of Positive Accounting with Respect to Accounting

During the time spent standardizing for isomorphism, individuals especially make weight upon association to execute work on as indicated by them. Decoupling is following part of next piece of hypothesis of institutional. Under decoupling, business association’s chief establishes the requirement for usage of practice & it could be not quite the same as present (appropriate) routine with regards to element. In this way, it is presumed that legitimacy theory covered institutional theory. Legitimacy theory assumes imperative part in present world.  Legitimacy theory assumes imperative part for society’s improvement (entirety). Legitimacy theory helps association to satisfy their objective productively and adequately by meeting society’s desire, by taking after applicable principles forced upon association under contract (social) (Gordon and Deegan, 1996).

As per surveyed the progressions done by US oil plants with respect to divulgence prerequisite. As indicated by hypothesis of Legitimacy, expanding substance’s revelation prerequisite as for oil factories causes general increment with respect to exposure necessity in the market. Legitimacy theory is a confirmed procedure (Shirley, 2010).Ramifications of theory fluctuates with the conditions in which association is playing out its exercises. Legitimacy theory covered positive hypothesis, stakeholders’ theory & institutional theory (Patten, 1992). The social contract is critical as for legitimacy theory. Legitimacy theory as for social contract acquires straightforwardness entire framework. 

Global reporting initiative (it is also known as GRI) was established in 1997, it is an independent institution which provides guidelines and framework for legitimacy accounting and reporting by business organization. Global reporting initiative is an initiative which is taken at the global level to provide guidelines and framework for legitimacy accounting and reporting. It provides standard for non financial information of the organization (social performance of the business organization and environmental performance of business organization).

Global reporting initiative is an international process whose aim is to develop framework for sustainable accounting and reporting for long term basis. The aim of the framework and guidelines provided by Global reporting initiative is to provide assistance to business organization for reporting of non financial performance of the business organization (Perera, Chowdhury and Goswami, 2007). In present, Global reporting initiative is an independent institution which is permanent. Headquarter of Global reporting initiative is located in Amsterdam in Netherland (Fitoussi, J.P., 2009).

According to Global reporting initiative, it is the responsibility of the business organization to provide information regarding social & environmental issue to the internal as well as external stakeholder of the business organization. It also helps business organization, government and other institute to report the impact of climatic change, human rights and corruption. G4 is designed which is applicable to all the organization, all across the world whether it is small or large. It was a big step taken by Global reporting initiative for development of society as whole and it brings transparency in the system of accounting and reporting of the business organization (Ruud, 2003).

Conclusion

Developments taken by Australia for legitimacy accounting and reporting are following:–      

– Environmental Protection & Biodiversity Act (1999)

– National Greenhouse & Energy Reporting Act (2008)

– Carbon Tax (2012) 

Conclusion

From above discussion, it can be concluded that “Application of social contract into legitimacy theory” has turned into a generic term. It is very important for the development of society. Reason for sustainable accounting is Legislative pressure, corporate responsibility, stakeholder pressure. Global reporting initiative provides guidelines regarding the same. As, we have seen that social contract have direct and indirect impact upon the business organization (Australian business). It is very important to promote the importance of legitimacy theory for the development of society as a whole. As, we have seen accounting bodies have positive attitude towards legitimacy accounting and reporting.

Sustainable development goals have positive impact upon business organization. Australian business organizations have to compliance with “Assurance engagements other than Audit or review of historical financial information (AS 110).”Measurement should be done the basis of Triple bottom line: people, planet and profit. From last few decades, importance of sustainability development has increased (Cornell and Carney, 1999).Pattern for reporting of financial information has changed and it shifted to green era from black & white era. Green accounting provides foundation to sustainability accounting and reporting (disclosure of non financial information).

In nutshell, it can be concluded that “application of social contract with theory of legitimacy in accounting field “contributes to development of society as a whole. 

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