Contract and its definition

Contract is defined as the agreement between two or more parties on the basis of which they decides to carry on particular thing with the defined terms and conditions. The contract is enforceable in the eyes of law. In case any of the party violates any of the term and condition of the contract then the contract will not be a valid one (Elahi, 2005). For instance contract is entered into between the two business parties namely A and B to carry on the business of manufacturing of brake parts upon the agreed terms and conditions. After some time B violates the term of contract.  Thus, the contract has broken. In this way the contract of any type will function. Other types of contracts which may include are that of marriage, citizenship, partnership, consultancy and other related components (Cruess, 2008 and Dunfee, 2009).

The word social in the term social contracts is referred in relation to Government (Baker, 2013). This reference itself is the beginning point of the social contract theory. These Governments are the results of the outcomes of compromise or the arrangement which the people made with the government. The contract if entered into between the Government and people is referred by the term of Social Contracts (Friend, 2016). Social contracts are very old nearly with the beginning of the philosophy. Social Contract theory lays down that the moral and the political obligations of the person are in total dependent on the contract or agreement that they have entered into with the social structure of the country in which they live in order to save themselves from the harm if any caused by the outside parties. In this contract people residing in the country surrenders their freedom to the Government in order to have protection from the outside harms (Frazer, 2017).

There are two old dialogues which Socrates has used to provide the application and implication of Social Contract theory in old period. 

In the beginning, as per platonic dialogue the Socrates has made the use of the theory of social contract as to inform why Crito shall be held remain for imprisonment and accept the penalty of death instead of escaping from the prison and moving to other Greek city. Socrates have referred that Crito has applied the law of Athens in the true spirit and said that his born and up coming in life is only because of the Law of Athens which have made his mother and father marry each other and gave the birth to the legitimate child. Being born in Athens, and receiving the good standard of living at Athens, Crito has total obligations towards the law and he has to abide by the laws and accept the death penalty. Thus, Socrates usage of the theory has been the successful (Leeson, 2009). The other argument which has come and has been simultaneously rejected by the Socrates is of Plato. Plato in his dialogue namely Republic argues that the social contract theory is the original source of justice. It has been so argued by Plato because of his statement that the justice is the outcome of the law, rules and regulations which have been framed by the Government and is taken by the people only to avoid any extreme situations like from being treated wrongly by others. Socrates has impliedly rejected the views and said that justice is state where the men have controlled and regulated mind and soul and it is far more than the obeying of laws, rules and regulations in the wave of having it exchanged from others (Jos, 2006).

Social Contracts and Government

The intent of the concept of social theory of accounting has come into the force from the period when there was Ancient Mesopotamia. But till the beginning of seventeenth century the social accounting theory has not gained much weight age but from the enlightenment period beginning from seventeenth century and till eighteenth century, the term social accounting theory has gained much weight age and importance. The period is known as enlightenment period because during this period people who were intellectuals have started questioning and arguing the various issues involving the religious, science, society, laws and Government, etc (Leonard and Samantar, 2011).

During this period three intellectuals come into known namely Thomas Hobbes, John Locke and Jean Jacques Rousseau and all of the three have given their efforts in establishing the views of Social Contract theory in standard form.  

Apart from this moral and political obligations and duties that each and every person has and Socrates discussion on the same area, there is modern social contract theory which was first introduced and explained by Thomas Hobbes. He has been in England in the most critical period between1642 to 1648 when there was English Civil War. At that time there was two conflicting arguments. One is that there shall be the traditional system of Monarchism in which there is only one ruler who will rule the state and is known as Monarch. Second conflicting view was that there shall be adequate and sufficient powers for the half democratic institution of the parliament (Mccarthy and Puffer, 2008). Hobbes in his explanation has given the compromise as well as the rejections for both of the conflicts in the following ways:

• Compromise – He has compromised by describing that the authority and power of ruler or king as provided by God and thus, political duties have been accumulated and made dependent on the religious belief and thus, rejecting the view of parliamentarians to have the power shared between the king and the parliament.
• Rejections – He has rejected both the views with two basic arguments which are radical and conservative. In his one approach he has categorically mentioned that the political duties and obligations are dependent upon the self interest behavior of the individuals with no single ruler and in his second approach respectively he has mentioned that in order to have society at large to be survived, it is better to have the single ruler called Monarch.

In this way Hobbes has analyzed and interpreted the dark view of humans which has been noticed during the period of English Civil War and he further stated that the individuals will be forced to do whatever will be required from them to do in order to survive. Therefore, in such a situation contract is necessary wherein the individuals will surrender their freedom to the king in return of the protection from the external harms (Smith, 2009).               

Another theory related to the social contracts has been proposed by Jean Jacques Rousseau. He during the period from 1712 to 1778 has written the historical pages which have led to the wave of revolution in France. He has started his theory by looking back on the ancient period when there were only two people on earth and who have started their lives in the state of nature and with the passage of time they have themselves progressed into the civilized society. They don’t know what to do and how to do any kind of work. As per his ideology, the state of nature was the best period as in that period they have uncomplicated lives and the peaceful mind and most importantly there was no competition as the population is very less. As the population increases the people satisfies their needs through other means and slowly tends to live in smaller families or groups and smaller communities. Thereafter establishment of proper divisions has been started which bifurcates the rich and poor families including labor. Rich families are those who have better standard of living and have their properties and poor families are those who are starving for having the better life and property. The need for having the social contract has arisen here. The rich families in the means of having their property saved from the poor families who can do anything through the illegal force to capture the property, enters into contract with the Government to save their property. Though the government contract shall ensure the equality for all irrespective of the financial status of the individual but in actual it has been formed for serving the interest of that community who are and have become well off in the society due to private property that has been gained by them at the cost of the poor families. Thus, this type of social contract has been defined as the naturalized one. Due to this contract, the various types of conflicts and the competition have come into place in the modern society. Moving on with this contract, Rousseau wants to have that type of contract which can bridge the gap between the unfair means of justice and wants to respond to this development with the proper and adequate resolutions (Skyrms, 2014).

Socrates’ usage of Social Contract theory

He thereafter advocated that the all humans were born free and is present in every chain of this modern world. He argued that all have freedom and was there in the state of nature but due to civilization this freedom has been vested in few hands of the society leading to comparisons, inequalities and dependence. It is not necessary to go back to the ancient state of nature as it will be neither possible for the society nor it is feasible to go back. He further stated that like other authors and ancient philosophers, all humans have been made through the nature and all have equal freedom and will. No person can control the freedom and will of the other person. Therefore, there is a need of having the one authority who can govern the society and such authority shall be originated from the agreements or the contract. Thus, from here the need of having the social contract is required so as to have equality among all and for all.            

In the nineteenth century, various new and recent theories have been given in relation to the social contract. Like John Rawls has given his theory in the year 1972, David Gauthier has given his theory in the year 1986, etc.  

Thus, in this way the social contract has come into place and has gained value in this modern world.

As per Suchman, legitimacy is the thought consisting of the assumption that the actions if any taken by the enterprise are adequate, sufficient and proper and that too within the defined standards, values, principles and beliefs (Burlea, 2013). In other words legitimacy theory is the mechanism through which the various companies in the industry ensures the full and complete disclosures relating to social and environmental challenges that is being met by the companies on daily basis in order to ensure the fulfillment of the social contract that they have undertaken which justifies the achievement of their objectives and their proper survival in the ever changing and dynamic environment. These disclosures so made by the company in their annual reports or the sustainability reports through which the society judges whether the company has been able to achieve the defined and expected results from the view of society or not. If it has been able to achieve then the company will be able to operate in the industry otherwise the company will badly be failed in the industry.

As per the current scenario, social and environmental challenges have poses the threat to the company along with the high pressure to comply with the instructions and guidelines for following the social and environmental regulations and make the companies to disclose the social and environmental related information on voluntary basis. Thus, in this way the legitimacy theory plays very important role for ensuring that the companies made adequate and sufficient disclosure of the information that is required under compliance.

The global financial crisis that have happened in the year 2009 has created the importance of the legitimacy theory and have been used worldwide specifically in the environmental and social related challenges. The financial crisis along with the instability of the industry and markets across the world, there has been the pressure on the organizations to restructure their systems and values and beliefs and since then the more emphasis has been laid on the significance of the theory of legitimacy. There have been many critics who have argued not to give so much importance to the legitimacy theory but with the majority the importance of having the legitimacy theory being the integral part of the compliances to be made by the organization have been emphasized and grown. Apart from this importance that the theory has been receiving, there has been one inherent disadvantage in the theory which underlines that the theory is sometimes described as the reasonable explanation of the motivation for the managers to make the compliance with the social and environmental regulations and requirements. It does not determine how to apply and make the relevant disclosure towards the environmental and social regulations rather act as a motivating factor for the managers to ensure that the company is complying with the relevant environmental and social related laws and requirements and have been making required disclosures (Makarkin, 2011). Thus, it ensures the voluntary compliances and voluntary disclosure of the environmental and social information.

The Enlightenment Period and Social Accounting Theory

The theory of legitimacy bridges the gap between the norms prevailing in the traditional era and the ethical climate that is being followed and is in operation in this modern world. The base of the legitimacy theory depends up on the three theories namely institutional theory, management theory and stakeholder theory. All the three theories have led to the formation of the legitimacy theory. Institutional theory laid down the processes by which the norms, values, beliefs and requirements, etc are built and established as the compliance requirements for judging the social culture employed in the organization (Patten, 2012). Institutional theory tends to develop the formal structures with the innovative techniques which will help the company to easily adopt the structures and thus ensuring that the innovations can be easily legitimized in the environment of the company. In case it is not so done, then it will be regarded as the negligent or irrational behavior of the individuals. Second theory is management theory which entails that how the managers and the employees of the organization shall be informed about the objectives and goals of the organization and how they will be motivated to achieve the goals of the organization along with meeting of the highest standard as defined by the industry in which the company is operating. Thus, management theory helps in directing the efforts of the managers and employees of the organization towards the achievement of the goals and the ways to motivate employees to achieve the goals with high standard. The third theory is the stakeholder theory. Stakeholder theory encompasses that the main objective of the business of any form is to increase or maximize the value of the stakeholders of the company. If the company does not have value for the stakeholders then the organization will fail as there will be no one who have or is going to have the interest in the working of the company (Donaldson and Preston, 2005). This theory also provides that the business ethics and organizational climate shall be followed and the moral values and beliefs that have been secured from different bodies and different authorities should not be sacrificed in any manner (Laplume, Sonpar and Litz, 2008). It is because the main crux of the stakeholder’s theory is of having the value of the stakeholder which totally depends up on the moral values and beliefs of the company and the adherence of the management and employees of the company towards these moral values and beliefs (Freeman, Harrison, Wicks, Parmar and Colle, 2010). In this way, the three theories form the basis of legitimacy theory and led to its evolution in the study. All the three underlying theories have laid the foundation of the theory and come up with the things which are required to be considered to legitimate the working of the organization in the legitimate way.           

The legitimacy theory in accounting, along with the disclosures relating to the environmental and social related information, also requires the company to give the relevant disclosures relating to the financial information. In accounting, the management of the company is required to prepare and present the financial statements of the company including the balance sheet and profit and loss account in the annual report of the company along with the director’s report and the sustainability report. The legitimacy theory motivates the managers to disclose all the relevant financial and non financial information to the users of the financial statements including the stakeholders of the company so as to increase the value of the stakeholder and ensuring the necessary compliance with the relevant law, rules and regulations prevailing in the business environment. It does not guide how the financial information or non financial information is required to be disclosed in the financial statements. It only motivates the managers to do so and that too with the core defined moral values, standards and beliefs.   

Thomas Hobbes’ Modern Social Contract Theory

Social contracts as defined by the Thomas Hobbes and Jean Jaques Rousseau has been the agreement which has been entered by the community to save their life from any danger that may be caused by the third party with the Government. The government includes the group of people who are selected from the members of the public only. This is done with the willful surrendering of the freedom by the individuals. Second view is of bringing the equality for all in the eyes of law and provides the justice by removing the inequalities.

Legitimacy theory on the other hand is linked with the motivation that is provided to the managers and employees of the company to give correct and accurate disclosure of the environmental and social related information to the users of the financial statements. It is not mandatory but voluntary.

Social contracts have great relevance to the legitimacy theory of accounting (Mäkelä and Näsi, 2010). It is because of the following reasons –

• The social contracts entered into by the company with the shareholder of the company will require the managers of the company to disclose the actual and correct financial results to the shareholders to ensure that the shareholder will invest in the company in the near future and thus they will be the potential investors of the company. This motivation reveals the presence of legitimacy in the disclosures of the relevant financial information.
• The social contracts entered into with the Government of the country in which the company is operating. In case the company refuses to comply with the requirements of the contract terms then the survival of the company will be in risk. Thus, the compliance with the contract terms of the government will always act as the motivating factor for the managers and employees of the company to disclose the relevant financial and non financial information and also the environmental and social related information. This motivation reveals the presence of legitimacy in the disclosures of the relevant financial information.
• The social contracts entered into with the customers of the company to provide the necessary information about the products or any similar thing on the timely basis to the customers. In case the company fails to provide the necessary information then the company will end up with the closure. This motivation reveals the presence of legitimacy in the disclosures of the relevant product and service information.
• The social contract entered into with the society of the country in which the company is operating requiring the company to comply with all the environmental and pollution hazards and their compliance shall be reported to the public on timely basis. This will again motivate managers to ensure the compliance of the same as the non compliance will hamper the working of the organization. This motivation reveals the presence of legitimacy in the disclosures of the relevant financial information.
• The social entered into with the other stakeholders including the financial institutions and banks of the company from which the company have outstanding loan or from which the company might be having some sort of finances in the near future requires the company to disclose the matters which is necessary for the financial institutions and the bank to consider before sanctioning extra loan to the company like the liquidity ratio and the current ratio, debt equity ratio, etc. It will act as the motivating factor in the sense that if the company fails to disclose the same to the financial institutions and bank then the company will face the shortage of funds and will end up with long term insolvency in the earlier stage. Therefore, it is necessary to disclose the same to the stakeholders. This motivation reveals the presence of legitimacy in the disclosures of the relevant financial information.

The above mentioned cases show that the social contracts are relevant to the legitimacy theory of accounting. The application of the social contracts to the legitimacy theory of accounting is mentioned and described in the definition of both the terms. Social contract on the one hand ensures that there will be equality for all and all will be governed by the same set of laws and procedures irrespective of the status of the individual or company. Legitimacy theory of accounting on the other hand describes that the necessary disclosures in the financial statements or any other report of the company is required to be made and that too within the predefined standards, beliefs and rules. These are disclosed to satisfy the contract which is termed as social contract in order to achieve the organizational objectives (Rosenfeld, 2014). Thus, social contracts laid down that why the managers and employees working in an organization are required to disclose the financial or non financial information of the company to the users of the financial statements and legitimacy theory of accounting acts as the motivating factor for employees and managers working in an organization to disclose the necessary financial and non financial information. Thus, the social contract is the guiding factor and the legitimacy theory of accounting is the motivating factor for the employee and managers to disclose the relevant information to the users of the financial statements.

Conclusion 

The social contracts have very important role in the development of community and the same have its origin since the inception of the human live. Thomas Hobbes and Jean Jacques Rousseau were the two great philosophers who have marketed the term of social contracts at everyone’s door especially to the industries and the companies operating across the world. In this literature review the historical background of social contracts have been given and explained with the different theories of philosophers and simultaneously the need for having the social contracts have been laid down. The legitimacy theory of accounting has been found innovative in providing the motivation to the managers and employee of the organization to disclose the relevant financial and non financial information. Social contracts have therefore very much relevancy with the legitimacy theory and shall provide more meaningful results. To conclude, the review has been detailed one and has provided the new area for research.  

Jean Jacques Rousseau’s Social Contract Theory

Every company shall disclose all the relevant financial or non financial information in their reports which are thereafter presented to the users of the financial statements in order to enable them to make effective and efficient decision. The disclosures are required by the different standards issued by the accounting standard board or the different laws, statutes, rules and regulations. Social contracts play very important role in ensuring the adherence of the provisions of the various laws, rules and regulations. The main aim of the review is to understand the importance of social contracts and how it has come into existence in the field of accounting. The second aim of the review is to understand the legitimacy theory of accounting and how the same has become so significant in the field of accounting and third major aim of the review is to know how far the social contract is relevant to the legitimacy theory of accounting and whether the results thereon will be useful for the users of the financial statements.

With these aims the review has been bifurcated in different section. First section has been mentioned as Literature Review within which the history of social contracts is detailed and the meaning of legitimacy theory and its importance has been mentioned. Along with this it is also detailed as to how far the social contract has been in connivance with the legitimacy theory of accounting. Then the conclusion has been given stating the findings of the review. Conclusion is followed by the introduction detailing the main aim of the review and the structure of the review that has been followed throughout the study. At the last executive summary has been given summarizing the main areas of study and the results of achievements thereon. The data for analysis has been collected from reliable primary and secondary resources.   

The title of the review is relevance and application of social contract in legitimacy theory of accounting. The social contract has gained its importance since the inception of the World and the same have been explained in detail with reference to the theories of two great philosophers Thomas Hobbes and Jean Jacques Rousseau. Both have laid down how the social contracts have emerged in this modern world. Thereafter the legitimacy theory of accounting has been detailed with reference to the environmental and social disclosures and thereafter with the disclosures required to be made for accounting results in the form of financial statements.

As the title suggests, the relevance and application of the social contracts to legitimacy theory of accounting has been judged and the results have been disclosed and interpreted there from. With this consideration, the review has been detailed in different headings and comes out with the result that the social contract has high degree of relevance to the legitimacy theory of accounting and its application in the latter will increase the value of the stakeholders of the company and thus increases the chances of survival of the company for long term in future.  

References 

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