Gerard provides an overview of Legitimacy Theory in accounting.

1. LO 2+3_1: Legitimacy Theory
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2. Legitimacy Theory
Legitimacy Theory asserts that organisations (businesses or
otherwise) are continually trying to influence society's perceptions
about them. They want society to see them as "legitimate".
Firms can expect to run operations that generally meet society's
expectations.
2 Created by Dr G. L. Ilott, CQUniversity Australia

3. Social Contract
Legitimacy Theory implies that there is a social contract representing
the norms and expectations of both businesses and society.
Social contracts, like society itself, is difficult to pin down. Expectations
and norms are always changing. What might have been demanded of a
corporation a decade ago might now be frowned upon.
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4. The contract works (roughly) as follows:
• The firm submits to the restrictions of society's expectations (in
other words, they are not free to lie, cheat, and plunder the
environment).
• In return, society approves by granting the firm legitimacy in its
estimations, and facilitates the flow of capital and resources to the
firm (so society has obligations under the contract too).
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5. However…
"Legitimacy" is not something the firm can acquire and build upon. It is only given
by society, and can be taken away.
The firm can only seek legitimacy. It therefore needs ways of "being nice" to society.
Accounting disclosures represent one way of telling society how nice the firm is.
Therefore, expect managers to make disclosures that might influence society and
gain greater legitimacy.
And the opposite is also true.
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6. The lifecycle of legitimacy
Firms are thought to go through a lifecycle, or phases of legitimacy:
1. Gaining legitimacy: Society bestows legitimacy upon a new organisation.
Uber & AirBnB have received a degree of legitimacy in recent years.
2. Maintaining/repairing legitimacy: Work has to be done to make up for
mistakes. Society doesn't like you quite as much any more. This might
explain why mining companies disclose lot of information about their
environmental efforts.
3. Loss/abandonment: The firm works out that it isn't worth the cost of trying
to be the "nice guy" of society. Think Big Tobacco.
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7. Legitimacy ≠ Accountability
Legitimacy is not the same as accountability. Accountability represents
the extent that the firm's governance requires those with
responsibilities fulfil them.
Legitimacy is the extent to which society thinks the firm is "legitimate"
and worth supporting.
It may be possible for a firm to be motivated in its disclosures by needs
for legitimacy that work against the need for accountability.
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8. Some problems with Legitimacy Theory
Even though Legitimacy Theory is not specifically a theory about accounting, it
has been criticised in the accounting literature. Broadly, the criticisms relate to:
• The difficulty of recognising when legitimacy concerns are in play, and
empirically measuring its affect on accounting decision-making.
• The motivation for seeking legitimacy may involve more complex strategies
from management than the rather simplistic view of Legitimacy Theory.
• Legitimacy Theory may be showing us nothing more than regular risk
management activities by management.
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9. My view on these criticisms
Criticisms are important for challenging views and sharpening our own critical thinking
processes.
I have no doubt that Legitimacy Theory offers us interesting insights into the
motivations of accountants and managers who decide what voluntary disclosures to
make.
That Legitimacy Theory doesn't play well with positive theorising does not of itself
mean that it is a bad theory.
And almost anything we study about financial reporting has strong links with risk
management strategies.
9 Created by Dr G. L. Ilott, CQUniversity Australia