Legitimacy theory states that organisations seek to ensure that they are realized as operating within the bounds and norms of their respective societies, that is they attempt to ensure that their activities are identified by outside parties as being ‘legitimate’. These bounds and norms are not fixed but change over time. The organisations are requiring be responsive to the ethical or moral environmental in which they operate. The supporters of the Legitimacy Theory also often rely upon the notion that there is a social contract between the organization and the society in which it operates. Social contract represents the multitude of the implicit and explicit expectation has about how the organization should conduct its operations. According to Gray, Owen and Adams (1996), the legal requirements provide the explicit terms of the contract, while the others non-legislated societal expectations embody the implicit terms. It can be argued that the traditionally the optimal measure of the corporate performance was profit maximisation. Under this concept of the social contract, the profit of the firm was viewed as an all-inclusive measure of the organizational legitimacy. The public expectations have changed so the organisations are now required to pay attention about the health and safety for the human, environmental and other social issues.
Corporate management would determine the terms of the social contract by legitimation. To be legitimate, the organization must conform to the terms of the social contract. According to Lindlom (1993), an organization is legitimate when its value systems are congruence with the value system of the larger social system in which the entity is a part. The organisation seeks to establish the congruence between the social values associated with or implied by the activities and the norms of acceptable behaviour in the larger social system. These two value systems are congruent as the notion of a social contract is linking with the concept of the organizational legitimacy.
Moreover, the social contract is a theoretical contract between one party, perhaps a company and the society. An individual cannot basically go and find a copy of the social contract between an organization and the society in which it operates. Different managers will have different perceptions about how society expects the organization to behave across the elements of its activities. They will have different expectations about how the organization should operate and the level of the accountability is due.
It is assumed within Legitimacy Theory that society allows the organization to continue the operations to the extent that it generally meets the expectations. About the extent, it means that it complies with the social contract.
On the other hand, the implication for a firm if it breached the terms of the contract is the organization may find it difficult to obtain the necessary resources and support to continue operations. Within a community that values a clean environment, failure to comply with the social contract because the company was with a poor social and environmental performance record. Furthermore, failure to comply with the terms of the social contract may lead to authorization that being enforced by society. For example, an operation of organization is in the form of legal restrictions, limited resourced such as financial capital and labour are being provided and the demand for its product is reduced because sometimes organized consumer boycott.
If an organisation’s management considered that the organization might not have operated in accordance with the community expectation, the management might rely on the source such as the media to shape the community expectations. O’Donovan (1999) provided evidence that the corporate managers believe that the media shapes the public concern and the annual report disclosures are a ways of winning back the support of the community after adverse media coverage.
For example, Brown and Deegan (1998) stated that the relationship between the print media coverage given to various industries’ environmental effects and the levels of the annual report environmental disclosures made by the firms. The media can be effective in driving the community’s concern about the environmental performance of organization. Finally, the organisations will respond by increasing the extent of disclosure of environmental information within the annual report.
Brown and Deegan used the extent of media coverage to measure the community concern. So, a good deal of research from a theoretical perspective is called Media Agenda Setting Theory. Media Agenda Setting Theory states that the media not only reflects the community concerns, but it can also set or create the community concerns. Increasing the media attention can increase the community concern for a particular issue. According to McCombs & Shaw (1972), the Media Agenda Setting Theory hypothesizes that the media shapes the public awareness with the media agenda has followed the public concern for the particular issues.
In the summary of Brown and Deegan, the organization should find a relationship between the disclosure of social and environmental issues within the annual report and the media attention if management responds to the community concerns and if the community concerns are affected by the media attention that place with the social and environmental issues. So, the higher levels the media attention, the higher levels of the environmental disclosures within the annual report.
Consistent with the Legitimacy Theory, the organization will undertake the various strategies to gain legitimacy if it considers that its legitimacy is threatened. One strategy would be to make the various disclosures within the media such as the annual report or the organisation’s websites. These disclosures could attempt to shift the attention to others.
The term “license to operate” in the statement refers to the social contract. The social contract communicated or implied the term that the organization need to comply with in order to gain legitimacy and hence the support from the society in various form. It comprises of the expectation from the society towards the operation of the organization in various aspects.
In the system-based theory, there is an interdependent relationship between an organisation and the society in which it operates. The organisation is considered part of the broader society and their actions may affect each other’s position or benefit. As such, there will always be some expectations or norms (either spelt out or implied) from the society towards an organisation as to ensure their well-being is not sacrifice while the organisation is pursuing its interest. That is the intention behind the social contract. It implied the congruent of the society’s value and the organization’s objective.
According to the Legitimacy Theory, in order to operate as a going concern, the organisation must demonstrate legitimacy in its operation. Such image of legitimacy can be gained by (appear to be) complying with the social contract. However, as mentioned above, some of the terms within the social contract are not spell out and the management must exercises their judgement to ascertain what are the actions acceptable or expected by the society. The organization will then do what they think the society expected them to do and avoid any action that is perceived to be undesirable by the society.
The annual report tells that some incidents or accidents related to Health, Safety, Environment and Community (HSEC) happened that may threaten the legitimacy of BHP. The incidents may result in not complying with the existing regulation or fail to appear to be meeting the expectation of society. In other words, BHP is breaching the social contract by failing to do what is expected by the society on the HSEC aspects. Hence, they might loose out the support from the society on what they are doing. Such supports they loosed out may in form of financial support, permission to undertake certain activities or consumption of products.
The ethical branch of stakeholder theory prescribe what should the company done towards its stakeholders. It would be rather normative in nature. An organization is viewed as a mechanism to coordinate the needs and interests of various stakeholders.
The researchers of this theory branch hold the opinion that those who influence or influenced by an organization’s decision is a stakeholder regardless their power over the survival of the organization. All of their interest should be considered while the organization making any decision. The management is believed to be motivated by responsibility and owed a fiduciary duty to the stakeholders.
The action taken by the organization should benefit all of its stakeholders instead of certain class. It is emphasized that all of the stakeholders should be treated with fairness and the interests of one class should not over-ride the other. No one’s needs are to be fulfilled in expense of the others as each of them have different key rights that should not be infringed. The management should seek a way to accommodate their needs where conflict of interests existed.
The fundamental right of each class of stakeholders may not be identical but should all be considered about. On equality, the stakeholders should be communicate with information which may impact them, ignoring the fact that they might not interested to use such information provided or they do not have power over the resources that the organization need. In other words, the management should furnish the information to the stakeholders when they realized the stakeholders might be affected by such matter.
The managerial branch of the stakeholder theory presumed that the management will prioritize certain class of stakeholders’ needs. The concept of equality is precluded from this theory branch.
The stakeholders are classified and ranked according to their power over the resources that the management need in attaining the objective. The management is believed to be motivated by self-interest or organization interest instead of the overall well-being of the society. They will put more effort in managing the relationship with those who exerted influence on the survival the organization while ignoring those who do not possess such ability.
One of the effective ways to manage the relationship with the powerful stakeholders will be providing prompt information to them. Needs of the powerful stakeholders will be prioritize over the rest.
It is assumed that the organization objective is to further its interest and corporate reporting is used as a mechanism to impress the powerful stakeholder and so obtain the required resources from them.