Legitimacy Theory

Legitimacy theory is a widely used theory in social reporting and views the organization as a part of a broader social system, in which an organization is influenced by and has influence on other parties as part of the given social system (Islam & Deegan, 2008). Legitimacy is defined as:

“a generalized perception or assumption that the actions of an entity are desirable, proper, or appropriate within some socially constructed system of norms, values, beliefs, and definitions” (Suchman, 1995 p.574).

It asserts that organizations attempt to ensure that they are perceived as operating within the norms and values of the respective society. These norms and values represent the expectations of the society. Legitimacy theory assumes that there is a social contract between a corporation and the society within which the corporation is operating (Reverte, 2009). The social contract is difficult to explain because it incorporates a multitude of explicit (codified norms and values) and implicit (non-

66 codified norms and values) expectations of the society (Shocker & Sethi, 1974 p.67). Moreover, the expectations of the society are not fixed but changing with the passage of time (Islam & Deegan, 2008). There are many factors such as increasing social awareness (Elsbach & Sutton, 1992), media influences (Ader, 1995 cited in O’Donovan, 2002), interest groups pressures (Tilt, 1994), corporate crisis (Marcus & Goodman, 1991), and the pressures form educational institutions, NGOs, and regulatory institutions (see Campbell, 2007) which are causing change in society’s expectations. The changing expectations and needs (representing norms and values) of the society will bring changes in the terms and conditions of the social contract between corporations and society and thus the corporations will be required to change themselves accordingly in order to maintain legitimacy16. Lindblom (1994 p.3) explicitly stated that: “Legitimacy is dynamic in that the relevant publics continuously evaluate corporate outputs, methods, and goals against an ever evolving expectation”. From the above discussion it is clear that legitimacy is a socially constructed and dynamic concept that is time and place specific. It requires corporations to adjust their actions/activities/operations along the lines of ever evolving expectations of the society. It tells us that corporate behaviour considered acceptable today may or may not be acceptable tomorrow. It also tells us that corporate behaviour which is acceptable at one place (i.e. in one country) may or may not be acceptable at the other place at the same time.

Organizational legitimacy can be further understood through a diagram presented by O’Donovan (2002).

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The corporations must change themselves with the changing expectations of the society (Shocker & Sethi, 1974 p. 1; Lindblom, 1994, p.3).

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Figure 4.1: Organizational Legitimacy

The above diagram presents two circles: the first circle represents a corporation’s activities and actions to a particular social event and an issue; and the second circle represents the society’s expectations and perceptions of a corporation’s activities related to the same issue and the event. In the above diagram, the areas have been marked X, Y and Z. Here X represents congruency between a corporation’s activities/actions and the society’s expectations about a corporation and its activities, while Y and Z areas show in-congruency between a corporation’s activities/actions and the society’s demands. In the above figure, areas Y and Z represent illegitimacy or legitimacy gap, while the area X represents legitimacy of the firm (O’Donovan 2002). It demonstrates that a legitimacy gap (or illegitimacy) occurs when perceptions about a corporation’s activities/actions do not match the expectations of the society. This legitimacy gap is not constant because the relevant publics’ expectations and/or perceptions about organizational activities may change.

“The legitimacy gap will fluctuate without any changes in action on the part of the corporation. Indeed, as expectations of the relevant publics change the corporation must make changes or the legitimacy gap will

68 grow as the level of conflict increases and the levels of positive and passive support decreases” (Lindblom, 1994 p.3).

This legitimacy gap can arise from the following reasons: 1) changing societal expectations, 2) the rate at which companies’ change does not match with the pace of changing societal expectations, 3) companies’ failure to disclose information about their activities to show that they are complying with the norms of the society, and 4) previously unknown unfavourable information becoming known to the public (Deegan & Unerman, 2011). These threats to organizational legitimacy are predicted to trigger responsive actions by corporate management to minimize the impact of the legitimacy threats (Islam & Deegan, 2008; Haniffa & Cooke, 2005). These actions, taken by the corporations, are considered to be part of a legitimation17 process (Gray et al., 1995a; Haniffa & Cooke, 2005). Lindblom (1994) has introduced four legitimating strategies that can be used by an organization when it perceives some threats to its legitimacy. Firstly, an organization can educate and inform about the changes made in its practices and performance to meet the expectations of the relevant public. Secondly, an organization can change the relevant public’s perception about its activities and performance without making any changes in the actual behaviour. Thirdly, an organization can deflect the relevant public’s attention from the issue of concern to another issue. Lastly, an organization can change the relevant public’s expectations by demonstrating that particular public expectations are not reasonable. These legitimating strategies can be used by a firm to gain, maintain, and repair legitimacy (Suchman, 1995). Dowling and Pfeffer (1975) highlighted three modes of actions taken by a firm to ensure its continued legitimacy:

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There is difference between legitimacy and legitimation: legitimacy is “a condition or status which exists when an entity’s value system is congruent with the value system of the larger social system of which the entity is a part” (Lindblom, 1994, p.2), while legitimation is a process that leads an organization to be adjudged legitimate (Islam & Deegan, 2008).

69 first adapt output, goals, and methods of operations to conform to a prevailing definition of legitimacy; second, alter the definition of social legitimacy through communication in order to conform to an organization’s present practices; and third, identify with symbols, values, or institutions which have strong bases for legitimacy through communication. Haniffa and Cooke (2005) linked Lindblom’s (1994) legitimating strategies and Dowling and Pfeffer (1975)’ proposed actions in the legitimacy theoretical framework and is illustrated in Figure 4.2. Moreover, the adoption of a particular legitimation strategy depends upon managers’ feeling of their proximity to legitimacy gap (Gray et al., 1995a; Haniffa & Cooke, 2005).

Figure 4.2: Link between Lindblom’s legitimation strategies and Dowling and Pfeffer’s legitimation

From the above discussion it is demonstrated that the adoption of each strategy requires a corporation to communicate with the relevant public. CSR disclosure can be employed by corporate managers in each of the legitimation strategies (Gray et al., 1995a; Lindblom, 1994) targeted to gain, maintain, or repair legitimacy (Suchman, 1995). In this context, CSR disclosure appears to be a tool that

70 companies could use to act, or to be seen to act, according to the society’s expectations (see Branco & Rodrigues, 2008). This disclosure can be symbolic and substantive in nature (Ashforth & Gibbs, 1990). Within legitimacy theory, legitimacy is considered to be a resource upon which the survival of the organization is dependent (Dowling & Pfeffer, 1975; Islam & Deegan, 2008; Mahadeo et al., 2011; O’Donovan, 2002; Suchman, 1995). This resource is bestowed by the society to an organization (Islam & Deegan, 2008) and organizations are able to impact and manipulate this resource through various disclosure strategies (Woodward, Edwards, & Birkin, 1996) as mentioned above. Furthermore, CSR disclosure can be used either in a defensive way in response to a legitimacy threat or in a proactive way to be recognised as a socially conscious company (see O’Dwyer, 2002).

This discussion of legitimacy theory focused on overall expectations of the society in explaining CSR disclosure and how an organization can ensure legitimacy status within the society. This will help a reader in understanding overall CSR disclosure rather than specific information disclosed by a corporation such as adoption of codes of conduct, membership of CSR promoting bodies, quality control department in the firm, and a CSR department in the company.

To understand the specific types of disclosure by a firm, it may be better to understand the concept of legitimacy in detail. Legitimacy can be understood in detail from a study by Suchman (1995) which identified three types of legitimacy: pragmatic legitimacy, moral legitimacy and cognitive legitimacy. Pragmatic legitimacy rests on the self-interested calculations of an organization’s most immediate audience and immediate audience involved in a direct exchange with an organization. According to Clarkson (1995) customers, suppliers, employees, and

71 local group (the government and the local communities) are involved in transactions with the firm and therefore these groups can be considered as a firm’s immediate audience. An example of pragmatic legitimacy can be found from the empirical literature about CSR disclosure in which companies listed in Mauritius disclosed relatively less environment related information than other CSR disclosure themes due to lower level of interest of immediate audience in the environment related information (see Mahadeo et al., 2011). To further explain pragmatic legitimacy, Suchman (1995) discussed sub-concepts: exchange legitimacy (in which an organization supports an organizational policy based on its expected value to its particular audience), influential legitimacy (in which an organization responds to its audiences’ interests), and dispositional legitimacy (in which an organization affiliates with its audiences’ values). Mahadeo et al. (2011b) argue that CSR disclosure containing information about the exchange between an organization and its audience, the acceptance of audiences’ values, and/or the adoption of audiences’ agenda, can be seen as a means of pursuing pragmatic legitimacy. This pragmatic legitimacy overlaps with the managerial branch of stakeholder theory (Mahadeo et al., 2011b) because according to pragmatic legitimacy an organization considers the interests of the immediate audience, which are considered powerful (or important) stakeholders in stakeholder theory (this theory will be discussed in detail in the following section). However, this overlap between stakeholder theory and legitimacy theory can be better predicted through the diagram (see Figure 4.3).

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Figure 4.3: Overlap between stakeholder and legitimacy theory

Moral legitimacy relies on managerial judgment that organizational activities are “the right thing to do” or promoting societal welfare (Mahadeo et al., 2011b; Suchman, 1995). In order to secure moral legitimacy, companies disclose pro-social activities and/or show their alliance with social imperatives e.g. alleviation of poverty, health and safety etc. (Mahadeo et al., 2011b). This point can be supported by some empirical evidence from a disclosure study of companies listed in Mauritius by Mahadeo et al. (2011). In this study it was found that the sampled companies spent 21% of word counted in describing employees’ health and safety related activities; and argued that companies might have been attempting, by communicating employees’ health and safety information, to be seen as doing the right thing e.g. taking care of employees (moral legitimacy). To explain moral legitimacy in detail Suchman (1995) discusses its sub-constructs: consequential legitimacy (judgement based on what an organization has accomplished e.g. amount of donations, amount of pollution reduced, amount of waste handled, reduction in health and safety accidents), procedural legitimacy (based on embraced socially accepted techniques and procedures e.g. adopting best practices to help the needy, ISO 14000, and ISO 9000 etc.), and structural legitimacy (based on presence of morally accepted structural characteristics e.g. CSR department, CSR committee, and quality control department etc.). The third form of legitimacy is not based on interest or evaluation

73 but based on managers’ cognition. Mauritian-listed companies’ ethical disclosure (e.g. adopting code of conduct) is an attempt to gain cognitive legitimacy by conforming to the established standards and models of ethics (Mahadeo et al., 2011).

There are numerous social and environmental disclosure studies which have used legitimacy theory. Of these a significant number of studies have found that legitimacy theory has explanatory power relating to social and environmental disclosure (see Deegan, Rankin, & Tobin, 2002; Haniffa & Cooke, 2005; Islam & Deegan, 2008; Mahadeo et al., 2011; O'Donovan, 2002; Patten, 1991; Patten, 1992; Reverte, 2009). Patten (1992) conducted an environmental disclosure study of petroleum firms, other than Exxon, after Exxon oil spill, and found a significant increase in petroleum companies’ environmental disclosure and viewed environmental disclosure as a method to respond to the expectations of the relevant public. Similarly, Deegan et al. (2002) examined social and environmental disclosure of BHP, an Australian company, and found a positive correlation between community concerns for social issues (measured by media attention) and BHP Ltd’s social and environmental performance. Another social disclosure study was conducted by Patten (1991) by conducting a regression analysis of 126 firms, in which the variable of ‘public pressure’ (measured by company size and industry) was found to be related to social disclosure. Haniffa and Cooke (2005) conducted a study to check the culture and the corporate governance impact on CSR disclosure and they found a significant relationship of the culture (proxied by malay directors on board) and the corporate governance (proxied by dominance of executive directors on board and chairman with multiple directorships) with CSR disclosure in Malaysia. They also conducted semi-structured interviews with senior executives to find reasons underlying CSR

74 disclosure, and found that corporate reputation, government support, and getting corporate awards (recognition) were reasons for CSR disclosure. A study was conducted to establish the determinants of corporate social reporting by Spanish listed companies by using three theories (legitimacy, stakeholder and agency theory) and found a significant positive relationship of large size, media exposure, and industry sensitivity (proxies of social visibility) with higher corporate social reporting rating and revealed that legitimacy theory is a more relevant theory for explaining CSR disclosure in Spain (Reverte, 2009). Mahadeo et al. (2011) conducted a study to establish company characteristic’s relationship with CSR disclosure and its dimensions and they found a significant positive relationship of company size with CSR disclosure and social disclosure (a dimension of CSR). They also found a significant positive relationship between company leverage and environment disclosure and health and safety disclosure. They argued that lower level of environmental disclosure, presence of ethical disclosure, and the existence of health and safety disclosures are seen as an attempt to gain pragmatic legitimacy, cognitive legitimacy, and moral legitimacy respectively. O’Donovan (2002) conducted semi- structured interviews with senior executives in Australian firms based on scenarios and found that disclosure is expected when there is a perceived legitimacy threat and disclosure is not expected when the perceived legitimacy threat is minimal and thus provided support for explanatory power of legitimacy theory to explain environmental disclosure. Islam and Deegan (2008) interviewed senior executives at BGMEA (Bangladesh Garment Manufacturers and Exporters Association) and found that CSR policies and disclosure practices of BGMEA are influenced by global expectations. Thus there are many studies which provide support for legitimacy theory to explain disclosure of social and environmental information. However, there

75 are some studies, which have questioned the explanatory power of legitimacy theory to explain corporate social disclosure (see O’Dwyer, 2002; Campbell et al., 2003). O’Dwyer (2002) conducted 27 semi-structured interviews with Irish publicly listed companies and partially supported legitimacy theory by arguing that the goal of CSR disclosure is to influence the public opinion in a proactive way (to be recognised as socially conscious company) or in a reactive way ( to regain perceived loss of legitimacy). He further stated that CSR disclosure can be part of legitimation process but he questioned capability of CSR disclosure to achieve the legitimacy status and highlighted that the existence of CSR disclosure in the interviewed companies may be due to motives that lie outside the legitimacy theory. Campbell et al. (2003) complemented the above finding by showing that some UK based companies, having a negative reputation (i.e. threat to legitimacy), did not disclose information. It indicated that there were some other factors which affected CSR disclosure.

It is evident from the above discussion that legitimacy theory not only incorporates the expectations of the society as a whole but also incorporates the expectations of the groups within society (see pragmatic legitimacy). Moreover, many authors have supported the explanatory power of legitimacy theory to explain CSR disclosure practice while some authors have questioned the explanatory powers of legitimacy theory and have argued that there are some factors which are beyond the scope of legitimacy theory. Moreover this theory fails to deal with contradictory and disparate expectations of the groups within society. So there is a need to discuss another theory, stakeholder theory, which provides mechanism to handle these groups’ contradictory expectations.

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