Importance of Stakeholder Thinking in Financial Accounting and

Reporting Analysis of the Reasons of Shortcomings in this

Relationship

Braham SOLTANI Maître de Conférences HDR,

Université Paris 1 Panthéon-Sorbonne, PRISM-Sorbonne

CR-15-04

PRISM-Sorbonne

Pôle de Recherche Interdisciplinaire en Sciences du Management

UFR de Gestion et Economie d’Entreprise – Université Paris 1 Panthéon-Sorbonne

17, rue de la Sorbonne - 75231 Paris Cedex 05 http://prism.univ-paris1.fr/

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Importance of Stakeholder Thinking in Financial Accounting and

Reporting –Analysis of the Reasons of Shortcomings in this

Relationship

Bahram Soltani*

Associate Professor and Director of Research

*Preliminary Version (Please do not Quote)

Prism (Research Center-Pôle de Recherche Interdisciplinaire en Sciences du Management)

School of Management Studies

University of Paris I Panthéon Sorbonne

Paper presented at the Annual Conference of the European

Accounting Association (EAA) in May 2015

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Importance of stakeholder thinking in financial accounting and reporting –

Analysis of the reasons of shortcomings in this relationship

ABSTRACT

This paper examines the importance of stakeholder thinking in financial accounting and reporting

by analyzing the theoretical literature, the statements of basic accounting theory, as well as the

conceptual framework, principles and standards which serve as the basis of accounting practices.

By formulating three research questions, we have mapped out the central issues that

undermine the importance of stakeholder thinking in financial accounting, both in theory and

practice. The study sets out to highlight the conceptual confusion and a number of shortcomings

that have continued to limit the well-shaped relationship between accountants and the potential

users of accounting information.

This paper contributes to the academic literature as it attempts to refocus and re-centre the

discussion around certain key issues regarding accounting-stakeholder interaction. In outlining

the key sources of concerns, both from stakeholder thinking and accounting perspectives, the

study also seeks to promote the debate on the expectation gap in accounting.

KEY WORDS: Accounting Theoretical Framework, Financial Reporting, Stakeholder

Thinking, ASOBAT, Expectation Gap

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INTRODUCTION

In the aftermath of the financial scandals and corporate deviances that began to surface from late

2001 to 2003, and following the recent financial crises, there have been calls for enhanced quality

of accounting information, as well as increasing quality and scrutiny in governance and control

mechanisms. The demand for immediate actions in these areas is mainly expressed by regulatory

bodies which are in charge of protecting the public interest in the capital market economy. There

has been a raft of laws, regulations, listings requirements and reporting standards in the areas of

accounting and finance in recent years.

There are a number of issues which need consideration in the discussion on the

relationship between accounting and stakeholders. Given the diversity of objectives among the

stakeholder groups, how would it be possible to satisfy their demands by providing the same sets

of financial statements and accounting information? Can the inclusion of the concept of

stakeholder in accounting conceptual framework and standards, which are considered as the

influential references in this field, be sufficient, taking into account that the framework and

standards are basically defined in a general manner and are not particularly established for

specific sectors of activity or groups of interest? Has the evolution of accounting and financial

reporting, in theory and practice, been affected by changes in organizational structure and the

demand of interested parties? What are the major problems, if any, regarding the effective role of

accounting in society in response to the demand of various interested parties?

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The paper seeks to analyze the the importance of stakeholder thinking in financial

accounting and reporting, the interaction between these two and the possible constraints affecting

the favorable outcome for stakeholders as the major interested parties of accounting information.

The paper discusses three research questions including the analysis of theoretical foundations of

accounting from stakeholders’ perspective (RQ1), the content analysis of the accounting

conceptual framework and standards from the viewpoint of the interests of various groups of

stakeholder (RQ2), and the analysis of the expectation gap as the possible constraint regarding

the favorable interrelationship between financial accounting and stakeholder thinking (RQ3).

We approach this interaction from different angles – theoretical, practical and regulatory

frameworks. Overall, the paper aims to provide a broad theoretical discussion in accounting

discipline from the stakeholder perspective. Our aim is to also analyze the effect of several

central topics on this interaction, including ethical climate, control environment, accountability

mechanisms, earnings management and market pressure, and management compensation

packages. Specifically, this paper focuses on the examination of theoretical foundation,

conceptual framework, and standards and practices of financial accounting and reporting from the

stakeholder perspective. Although the importance and possible contribution of stakeholder

thinking in accounting will be debated in several parts of the paper, an in-depth discussion of this

issue around the topics such as social justice theory, legitimacy, theory of ethics, and moral

doctrine go beyond the scope of the paper and are not specifically debated.

In line with this goal, the present paper aims to respond, in two specific ways, to the need

for further research highlighted in previous studies. First, we extend the analysis of stakeholder

thinking in accounting discipline and financial reporting as one of the important fields of

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knowledge and a means of communication and control of information in which the stakeholders

should naturally have particular interest, a topic which has not been sufficiently discussed in

academic literature. Second, the paper provides an insight into accounting and stakeholder

interaction by highlighting a number of problems which may be determinants in this relationship.

In outlining the key sources of concerns, both from stakeholder thinking and accounting

perspectives, the present research seeks to promote the debate on the expectation gap and the

reasons for such a difference between what the users of accounting and financial information

expect and need and what accountants could and should reasonably expect to accomplish.

In this regard, this research study may have several academic and practical contributions,

particularly because of its wide scope with respect to theoretical analyses and the discussion on

accounting standards, conceptual framework and reporting practices. The topics may be of

interest to market regulatory bodies, accounting standard setters, corporate management and

various groups of stakeholders.

The paper is organized as follows. After discussing the research motivation and the study’s

contributions, we shall begin with an introduction to our theoretical framework for the study.

This includes the theoretical discussions on stakeholder thinking, accounting as an applied

science and interaction between both these fields. The third section presents the research

questions and the discussions. Concluding remarks of the study will be provided in the final

section.

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RESEARCH MOTIVATION and CONTRIBUTION

The research topic of accounting for stakeholders may be one of the ‘big unanswered questions in

accounting’ since discussion on this issue provides insights into the fundamental objectives of

accounting information and its scope. This discussion naturally raises other relevant questions:

what is the major role of accounting information and financial reporting? Should we investigate

the shortcomings of accounting and financial reporting from the viewpoint of stakeholder

interests, if any, by searching into the scientific background of accounting or should we attribute

the possible problems to accounting and corporate reporting practices? What is the potential of the

stakeholder perspective in improving financial decisions? Does the problem reside in the scope of

accounting and finance which is more oriented towards the needs of the capital market economy

and profit maximization? Do management, who are in command, and the accountants, as the

providers of accounting information, have any fiduciary duties, in mandatory and voluntary

financial reporting, towards stakeholders? Who are the stakeholders and whose interest

accounting should serve? Considering the use and interpretation of accounting information as one

of the most vexed and ill-resolved accounting problems, Lee argued that the problem is “not only

what is to be accounted and reported, but also for whom the resultant financial reports are to be

produced” (1979, p. 22).

This paper aims to discuss the above interrelated questions in the context of financial

accounting and stakeholders’ relationship. Although the discussion may indirectly contribute to a

better understanding of the importance of the stakeholder view of organizations in other related

areas such as management accounting and auditing, it specifically deals with financial accounting

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and reporting. In this regard, accounting and financial reporting are separate but interrelated

fields since the accounting rules and standards do not fully determine corporate disclosure

policies and financial reporting practices. The latter is strongly influenced by the manager’s

perception and judgment as well as by environmental factors and the pressure exercised by

potential users on disclosure policies of corporations.

There are also a number of issues which need consideration in discussing this

relationship. Given that the stakeholders are not homogeneous groups in terms of interests and

objectives, as well as the power of negotiation and influence in the accounting standard-setting

and corporate decision-making processes (for instance major shareholders [such as institutional

as opposed to minority stockholders], creditors, auditors, regulators are all actively involved and

have a strong position in these areas), what do we mean by including the stakeholder concept in

accounting? Does part of the problem regarding the interaction between accounting and

stakeholder thinking come from the ambiguity of the latter as highlighted by Parmar et al. (2010,

p. 406)?

This paper aims to discuss the above questions by analyzing the notable theoretical

literature and conceptual framework which are used as the main sources in standard-setting,

interpretations of concepts, practices, and disclosure policies in accounting and financial

reporting. The main goal of the paper is to give some insight into accounting and financial

reporting from the perspective of the stakeholders’ interests. Accounting is an applied science

with a great many practical implications for society. For this reason, our research analyses

include both theoretical (Research Question 1) and practical (Research Question 2) dimensions

from the stakeholder-thinking perspective. Accounting as a field of knowledge is also

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substantially influenced by environmental factors (economic, laws and regulations, socio-

political). For this reason, our research analysis needs to be made by taking into account the

evolution of accounting from a theoretical perspective as well as the significant changes in the

capital market economy.

The above discussion is followed with a final question which deals with the possible reasons

and shortcomings regarding the absence of stakeholder thinking in the conceptual framework and

standards which underline accounting practices. The objective of this research question is to

discuss the factors which go beyond accounting theory and practice, notably the ethics and tone

the top, the bubble economy and financial market pressure, earnings management and its link

with management compensation packages, accountability and control mechanisms.

The aforementioned specific characteristics of the present study provide potential

contributions towards a better understanding of the root causes of the expectation gap between

what the public expects or needs and what accounting can and should reasonably be expected to

do. In summary, the contribution of the paper is threefold. First, the paper tries to provide an in-

depth theoretical discussion of accounting discipline from the stakeholder perspective. Second,

the paper provides an insight into the accounting conceptual framework and standards by

conducting a content analysis from the stakeholder perspective. Both these issues should have

practical implications for regulatory bodies and accounting standard-setters seeking to respond to

increasing public demand for high-quality accounting information and effective financial

reporting policies. The third contribution of the paper is to raise a number of ambiguities or

confusions which may exist both in accounting and stakeholder thinking. Part of these may relate

to the nature of the capital market economy and capitalist society which are essentially directed

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towards profit and wealth maximizations. The shortcomings may also relate to over-reliance upon

theoretical generalizations of stakeholder ideas in practical fields such as accounting. Above all,

as the present study covers a large number of literature reviews regarding the above topics, it

contributes to the academic literature in social accounting, stakeholder thinking and their

interaction.

THE THEORETICAL FRAMEWORK: STAKEHOLDER THEORY AND

ACCOUNTING DISCIPLINE

Our theoretical framework for the analysis of stakeholder and accounting interaction is based

upon a review of a wide range of published literature in both fields. Due to the much longer

historical background and wider scope and development of accounting discipline compared to

stakeholder theory, particular emphasis is placed upon the theoretical foundations of accounting

and its conceptual framework and principles from the stakeholder perspective. This framework

should provide a clear illustration of our arguments and serves as a useful instrument for defining

the relationship between accounting and stakeholder thinking. In addition, this analysis

contributes to shedding light on several significant shortcomings which, in our opinion, have a

tremendous impact on the smooth running of this relationship in a harmonized manner within a

capital market economy. We believe that this approach contributes to further research and debate

in this area, provides some understanding of the complexities of this relationship, and reinforces

the constructive dialogue between accountants and stakeholders.

We present in the following sections an overview of the stakeholder theory and the related

issues, the evolution of accounting theory from the stakeholder perspective.

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Stakeholder theory and related issues

The discussion on the concept of ‘stakeholder’ dates back to several decades ago and has its

origins in theories of organization and management. Since its emergence in the 1960s, it has

become a highly debated and controversial idea. The term was popularized by Freeman (1984)

who later widened the stakeholder definition to include “any group or individual who can affect

or is affected by the achievement of the organization’s objectives” (1984, p. 46). It concerns the

individuals or groups of interest (financiers [stockholders, bondholders, bankers, etc.]

management, employees, customers, suppliers, auditors, regulatory bodies, etc.) who are directly

or indirectly involved or associated with the objectives and survival of a particular organization.

Donaldson and Preston (1995) believe that “stakeholders are identified through the actual

or potential harms and benefits that they experience or anticipate experiencing as a result of the

firms’ actions or interactions” (1995, p. 85). In line with this statement, Kaufman and Englander

(2011) argue that “the firm’s economic purpose designates legitimacy to core stakeholders, to

those who add value, assume unique risk, and can incur them” (2011, p. 422). Parmar et al.

(2010, p. 405) stated that stakeholder theory is based on the premise that if we adopt as a unit of

analysis the relationship between a business corporation and these individuals and groups who

can affect or are affected by it, this would contribute to resolving problems associated with

capital market economy and managerial ethical conduct.

This section does not aim to present a review of the evolution of stakeholder thinking nor

its theoretical arguments. This has been done by the pioneer scholars in this field in several

studies including Freeman (1984, 1994, Freeman et al. (2007, 2010), Parmar et al (2010), 10

Donaldson and Preston (1995), Jones and Wicks (1999). The merit of these scholars and their

research work is to highlight the importance of the ‘stakeholder thinking’ as an alternative or

complementary management approaches. It would be hard to say to what extent these attempts

were successful, taking into account the dominant position of the theory of the firm particularly

its economic branch in the capital market economy. However, in our opinion, the good side of the

story is that the attempts of the scholars in this field at least contribute to bringing the concept of

stakeholder thinking to the centre of academic debate. The negative side is that despite all these

attempts, there is no consensus either on the definition of stakeholders, or on the validity of its

theoretical foundations and associated concepts as along with its practicability. For instance,

Jones and Wicks (1999) advocate the use of term such as ‘convergent stakeholder theory’, and

‘theory of relationships’ by stating that “managerially relevant stakeholder theory should be both

morally and instrumentally sound (i.e., have both normative and empirical components) whereas

Trevino and Weaver (1999) question the very viability of stakeholder theory as a social science

theory. Trevino and Weaver suggest “the phrase stakeholder research tradition in part because

[they] find the myriad ways in which the term theory gets used in stakeholder writings potentially

confusing” (1999, p. 623).

The stakeholder theory and its concepts have been subject to several criticisms notably

with regard to the ambiguity in the definition of the term ‘stakeholder’ and its theoretical content.

By examining the stakeholder literature and central criticisms of this field from both the neo-

liberal and Marxist/radical perspectives, Stoney and Winstanley (2001) have tried to illustrate the

conceptual confusion that has, in their opinion, continued to limit the impact of stakeholding in

organizations and society as a whole. They concluded that “current arguments for stakeholding

suffer from an over-reliance upon theoretical generalizations, a high degree of emotion and some 11

less than convincing empirical data. In short the concept of stakeholding remains under-theorized

and under-researched and unless both these deficiencies are confronted the stakeholder debate is

in danger of becoming increasingly marginalized” (2001, p. 623). Similarly, by referring to more

than several hundred definitions and types of academic discussions around the term ‘stakeholder’,

Miles (2012) explores whether the lack of consensus on the definition is conceptual confusion or

whether the stakeholder concept is essentially contested. Drawing upon the work of a renowned

philosopher W. B. Gallie, who initially defined the ‘essentially contested concept (ECC)’ and on

the basis of whether a concept is “vague, ambiguous, general, complex and normative” (2012, p.

286), Miles believes that “the stakeholder concept is essentially contested rather than radically

confused” (2012, p. 294). With respect to the lack of clarity on the term of stakeholder, Miles

suggests that “whilst a universal definition is not necessary, there is a need to refine the common

core that ensures arguments do not become over aggregated (2012, p. 296).

The place and importance of stakeholder thinking in current economic environment and

organizations need several considerations. The first and most important element, in our opinion,

is related to the analyses of the structure and the environmental characteristics of capitalism and

market economy. “Does stakeholder theory offer an alternative to capitalism and contest the

shareholder model? Or does it offer a narrative on how capitalism might work better?” (Sonpar

2011, p.1). Although the discussion on this question goes beyond the scope of this paper, it is one

of the key issues. Indeed, most influential accounting theories which have been introduced over

the last three decades, as well as the conceptual framework and generally accepted accounting

principles and standards have been developed for the benefit of the capital market economy and

oriented towards the needs of financiers (shareholders, bondholders, bankers) and intermediary

agents (auditors and financial analysts).. It may be argued that “Stakeholder theorists see the 12

separation of moral good and business success as artificial and unhelpful” (Sonpar 2011, p.1).

Freeman et al. (2010), in the first chapter of their book compare and contrast the compatibility of

stakeholder theory with other leading economic theories which support value creation and wealth

maximization. They believe that these two are not incompatible because the market financial

targets can only be attained if the interests of various stakeholders are met. This argument is

interesting from the viewpoint of society’s welfare but is not supported by empirical findings.

Above all, the same authors in another research paper (Parmar et al. 2010) acknowledge the

limitations and boundary conditions of stakeholder theory. Indeed, the notion of stakeholder

thinking can be understood from a conditional-normative point of view but its practical

implications depend on a different way of thinking of capitalism, more in line with a welfare

society, a range of equality factors, and with justice and ethics as an imperative.

Our second observation is that the stakeholder theory, and particularly its practical

implications, requires certain changes in the laws and regulatory framework. This has also been

pointed out by Parmar et al. (2010, p. 408). There are several controversies on this issue and the

authors (Marens and Wicks 1999; Hendry, 2001a, 2001b) do not have consensus regarding the

impact of laws on the effectiveness of stakeholder thinking within enterprises. We would prefer

to discuss this issue differently. Although we strongly believe that the laws and regulatory

framework tremendously contribute to stakeholder dialogue within corporations, it does not

assure the respect of principles from the stakeholder perspective. In our opinion, the success of

corporate issues and practices cannot only reside in laws and regulations since the organizational

functioning, to a great extent, depends on behavioral factors and the perceptions of decision-

makers and market participants. Finally, as pointed out by Soltani (2013), particular attention

should be paid to the core issues such as ethical climate and ethical leadership, as well as control 13

environment, effective accountability and corporate governance mechanisms. Some of these core

values are used and discussed in Research Question 3.

Evolution of accounting theory from the stakeholder perspective

In a series of essays published over 80 years ago, Professor Theodore Limperg set forth a

dynamic theory called the theory of rational expectations (or the theory of ‘inspired confidence’,

Limperg 1926- see Limperg Institute 1985) that connects a society’s need for reliable financial

information to the ability of auditing methods to meet that need. Limperg explained how changes

in the needs of society and changes in auditing methods interact to bring about changes in the

auditor’s function. “Limperg based his theory on the science of business economics and viewed

the development of the audit function from an economic perspective” (Carmichael 2004, p. 128).

The ideas of Professor Limperg were partially followed by two other scholars Mautz and Sharaf

who published The Philosophy of Auditing (1961) - a project whose origins can be traced back to

the 1930s.

The seminal work of Limperg is characterized by several important elements relevant to

our discussion with respect to accounting from the stakeholder perspective because auditing is the

process of providing assurance about the reliability of the information gathered in accounting

process notably the financial statements.

Despite the attempts made on socially-oriented theoretical research in accounting and

auditing at the beginning of 20th century, the field of accounting was practically dominated by a

stewardship view of management and the concept of economic income until the mid-1960s.

Under this approach, management can be viewed as an agent to whom capital suppliers (i.e.,

shareholders and creditors) have entrusted control over a portion of their financial resources. This

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‘stewardship’ view implies that management has a responsibility to act in the interests of the

financiers in performing different roles including productive agent, risk bearer, and supplier of

information. By providing financial statements to financiers, management facilitates also their

evalutaion of its stewardship role.

In line with this argument, the accounting scholars mainly emphasize the economic role of

financial reporting and do not advocate that the field of financial reporting is socially oriented

and has a responsibility to various interested parties. Beaver (1989), one of the accounting

scholars, supports the informational role of accounting defined on the basis of the stewardship

concept by stating that the two main objectives of accounting is to help investors in their

investment decision-making process and to facilitate contracting between management and

investors particularly in terms of management incentives.

Ball (2008) considers that “financial reporting is an important economic activity” (2008.

p. 428) and believes that the main issue which should be discussed is “the actual economic role of

financial reporting” (p. 427). This discussion has initially been raised by Watts and Zimmerman

(1986), and throughout the last two decades it has been followed by numerous empirical research

papers on topics closely linked with financial market such as the value relevance of financial

information, the effect of earnings variables on stock prices and investors’ decisions.

Several research papers are interested in the place and importance of stakeholder thinking

in accounting. Roberts and Mahoney (2004) present a review of 125 accounting studies that

utilize stakeholder language and which are based on three levels of analysis (managerial agency,

organizational and societal). The authors state that the literature on stakeholder-based accounting

“differs significantly in its use of stakeholder theory depending on the level of analysis that was

chosen” (2004, p. 410). Although, the authors raise the question of the importance of stakeholder 15

thinking in accounting and how can accounting researchers participate in the development of

stakeholder theory, they do not provide the solid arguments for the absence or shortcomings

regarding accounting-stakeholder relationship. They suggest the need for more focus on “ethical

considerations in the design of accounting information systems, performance measurement

criteria, and financial reporting models” (2004, p. 399).

Parmar et al. (2010) provides an overview of some of the studies on the interaction between

accounting and stakeholder theory. They emphasized the importance of accounting as a control

instrument and financial reporting system from the view-point of various interested parties as

well as the influence of stakeholder thinking particularly in the areas of reporting on corporate

social responsibility, disclosure practices, auditing and corporate governance.

RESEARCH QUESTIONS

Based on the objectives outlined in our research motivation and theoretical framework, we

examine the following three research questions (RQ). The first two questions (RQ1 and RQ2)

analyze the accounting theories, statements, conceptual framework and principles from the

stakeholder perspective. RQ3 discusses the main reasons of the absence or the shortcomings of

stakeholder views in accounting practices and financial reporting.

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Research Question 1

To what extent does the analysis of theoretical foundations of accounting provide a clear link

with the stakeholder theory in the area of the objectives accounting?

The efforts in defining the theoretical framework and objectives for accounting dates back to the

1930s. The American Accounting Association (AAA) published, in 1938, the first guideline,

entitled ‘Statement of Accounting Principles’. This document stated that “accounting should

make available all material information of a financial nature relating to (a) the financial condition

or status of the business, (b) its progress in earning income” (AAA 1938, p. 113), and mainly

presents an overview of the accounting principles and general considerations regarding the

components of financial statements, forms and terminology. No particular reference to decision-

making process and the users of accounting information was made in this document. The first

complete statement entitled the ‘Statement of Accounting Principles’ published in 1936 by the

Executive Committee of the AAA is a landmark in the development of accounting theory (AAA,

1966, pp. vii). However, this statement contains no theoretical arguments or framework regarding

accounting issues.

From 1936 through to 1964, the AAA published three other statements and several

documents regarding the development of accounting theories and principles, but none of them

greatly contributed to achieving these objectives. The Statement of Basic Accounting Theory

(AAA, ASOBAT 1966) was the first attempt by the AAA in this respect. The ASOBAT defines

the following objectives of accounting:

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1. Making decisions concerning the use of limited resources, including the identification of

crucial decision areas, and the determination of objectives and goals.

2. Effectively directing and controlling an organization’s human and material resources.

3. Maintaining and reporting on the custodianship of resources.

4. Facilitating social functions and controls (AAA, ASOBAT 1966, p. 4)1.

Comparing the content of the above statement with those issued either by the AAA or

standard-setters from the 1970s onwards shed light on a drastic change from a public interest

perspective to a market-oriented direction. Although the ASOBAT does not explicitly refer to the

usefulness of accounting for stakeholders, it does not also emphasize the importance of particular

economic agents such as stockholders and creditors who have later been identified as the main

groups of interest in several influential accounting theories and documents. ASOBAT clearly

highlights the importance of the identification of various types of accounting information for the

benefit of the users to which this information may be put. The Statement considers that “almost

all external users of financial information reported by a profit-oriented firm are involved in

efforts to predict the earnings of the firm for some future period” (ASOBAT 1966, p. 23).2 This

remark particularly sheds light on the importance given to all stakeholders, in early accounting

literatures, as the beneficiaries of accounting information regarding the decision-making process.

Taking into account the difficulties associated with the disparity of goals and objectives among

stakeholders, the Statement advocates that “these users are necessarily stated only in general

terms, because the decisions of users cannot be described in terms of fully known and detailed

decision models” (ASOBAT 1966, p. 23). Above all, the ASOBAT makes several interesting

remarks relevant to our discussion, such as “success in decision-making must be judged in terms 18

of the goals of those on whose behalf the decisions are made, subject to legal and moral

constraints imposed by society”, or it refers to the responsibility of management in terms such as

“the function of stewardship or custodianship may be a managerial function … The interests of

society are paramount in defining this function … Providing information relating to compliance

with (these) laws is essentially an accounting function” (ASOBAT 1966, p. 4)3. The Statement

also specifies that “other social functions in which accounting plays important roles including

taxation, the prevention of fraud … The accounting objective is to facilitate the operations of

organized society for the welfare of all” (ASOBAT 1966, p. 4)4. The italicized words and

sentences extracted from the ASOBAT clearly demonstrate the importance given to social

interest and society as a whole, the objective which is also in line with stakeholders’ interests.

The stakeholder view of accounting, clearly expressed in several official AAA documents

published during the 1950s to 1960s, was not fully shared by all academic scholars at that time.

For instance, although Flanders (1959), stated that “accountants are culpable for their apparent

lack of desire and effort to share substantially in the teaching and research of this large and

strategic area of social accounting” (1959, p. 68), he did not present a clear argument on the

association of accounting with social phenomena. Flanders pointed out that “both economics and

accounting attach meaning and value to what can be termed the three elements of social

interaction: namely, motivation, behavior, including action as well as thinking, and the resultants

of behavior” (1959, p. 72). This statement, at first reading, may refer to social values in

accounting. However, his remarks were not specifically related to social values in accounting

because in his following sentence he stated that “economics and accounting have an important

common point of departure because both assume similar pecuniary motivation. This motivation

includes profits and often other goals such as share of the market”5 (1959, p. 72). Furthermore, 19

by referring to the definition of accounting theory provided by another accounting scholar of that

time (A. C. Littleton 1950), Flanders emphasized that “accounting theory is concerned with the

best means of determining and presenting information about economic stocks and flows, in

relation to the purposes for which such data are to be used” (1959, p. 72).

The emphasis of the notion of stakeholder interests in theoretical accounting literature

published in the 1980s was less important than the one outlined above with respect to ASOBAT

(1966). For instance, Devine (1985) in his series of essays published by the AAA emphasized

that “If accounting principles are rules derived from behavioral and social generalizations, then

their usefulness and their consistency must be appraised in the broader context of goal-striving

activities and worthy social ends” (1985, Vol. I, p. 15). The idea of defining accounting based on

achieving social goals is not always shared as a primary objective of this discipline even among

the scholars who have expressed vigorous critical analysis of contemporary accounting.

Mattessich (1995) believes that “the social truth is so general that it reaches beyond the

framework of accounting. The major goals of accounting proper are, on the one hand, the

monitoring of custodial, financial, and managerial accountability; on the other, the supplying of

further information to facilitate various decisions (primarily of investment and resource

allocation)” (Mattessich 1995 p. 81)6. However, the definition provided by Mattessich has a

particular merit in the sense that unlike some other scholars, who support the idea of a single

objective such as the determination of income or equity in conventional accounting, he suggests

multiple goals for accounting. This is also shared by Lev (1988) who rejects the idea of a ‘single’

objective in accounting information and states that “what is highly useful information for some

investors might be irrelevant or even damaging … for others” (1988, pp. 2-3).

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The accounting discipline has also been dominated by positive theory which is used as the

basis of the significant part of economic-based empirical literature since the 1970s. Jensen (1976)

and Watts and Zimmerman (1986) have charged that most accounting theories are “unscientific”

because they are “normative”. The terminology of positive theory was popularized by Friedman

(1953), but as it was pointed out by Watts and Zimmerman (1986, p. 5), the introduction of the

concept of positive theory came as a result of the developments in finance in the 1960s mainly in

the area of efficient market hypothesis. In their views, economic efficiency is frequently used as

an objective in economics and accounting. Watts and Zimmerman advocate that “positive

accounting theory is important because it can provide those who must make decisions on

accounting policy (corporate managers, public accountants, loan officers, investors, financial

analysts, regulators) with predictions of, and explanations for, the consequences of their

decisions” (1986, p 14)7. This objective clearly excludes all stakeholder groups except

shareholders, creditors and the intermediaries serving their interests. Although the theory is based

on the contracting role of accounting, it is limited in scope as it uses mainly the agency concept

of Jensen and Meckling (1976) in defining the manager/shareholder relationship, debt contracts

and management compensation packages.

The positive theory of accounting has been subject to several criticisms. Watts and

Zimmerman, the authors of the theory, acknowledge themselves the shortcomings of this

approach but advocate that “the lack of a well-developed positive accounting theory results from

the lack of rich economic theories of the firm (including the contracting process) and of the

political process” (1986, p. 357). Christenson (1983) raised a number of questions regarding the

scientific background of this theory and the appropriateness of its methodological concepts.

Mattessich (1995) advocates that one of the major shortcomings of the positive theory of 21

accounting, similar to ‘economic-based accounting’, is “the overriding influence of a single

objective, namely wealth maximization. … A related issue is the neglect of environmental and

social issues” (1995, pp.167)8.

The question of the usefulness of the accounting information for various stakeholders may

be explained in the context of its social role. Miller (1994) has argued that “accounting has come

to be regarded as a social and institutional practice, one that is intrinsic to, and constitutive of

social relations, rather than derivative or secondary” (1994, p. 1). However, his arguments mainly

concern the significant position of accounting as a technology and means of communication in

the functioning of modern industrial societies and corporations, rather than responding to the

expectations of various groups of interest. The point that accounting has policy implications in

society, and affects economic decisions (for instance, in the determination of cost, price and

taxes) does not imply that the current accounting systems include the obligations and

responsibilities towards various interested parties.

In response to Research Question 1, we make three concluding remarks. First, although

there is clear evidence of socially oriented objectives and stakeholder views in several official

accounting statements released in the 1960s (notably the statement of ASOBAT) and earlier

periods, this did not have any practical implications for the users of accounting information,

mainly because of a lack of development in the financial market and insufficient public

awareness at that time. Second, the income and profit maximization have always been the

dominant concepts in the accounting literature in the last few decades. As stated by Beaver (1989),

in the late 1960s the perspective shifted from economic income measurement to an ‘informational’

approach. In the views of Beaver, financial reporting data which are mainly presented on the

22

basis of accounting information play two distinct, but related informational roles. The first main

objective is to help investors in their investment decision-making process and the second is to

facilitate contracting between management and investors, particularly in terms of management

incentives. Both these objectives are essentially related to owner-manager relationship and do not

involve other interested parties (stakeholders). This limitation could also be clearly highlighted

when Beaver referred to the financial reporting environment including various constituencies

such as investors, policymakers, management, auditors, and information intermediaries (1989,

p.160). Our third observation is that providing the useful information to various stakeholders

requires an efficient communication policy and effective control mechanisms which assure the

equal access of all interested parties to information. This will not be an easy task unless

management is willing to do that and is subjected to resolving the problems of information

asymmetry and conflicts of interest resulting from the diverse objectives among stakeholders.

Research Question 2

To what extent does the content of the accounting conceptual framework and standards

include the issues regarding the interests of various groups of stakeholder?

We first consider this research question in the context of ASOBAT, which specifically refers to

accounting information for external users who include present and potential investors, creditors,

employees, stock exchanges, governmental units, customers, regulatory commissions and tax

authorities. Representatives of these users, such as security analysts, trade associations, credit

rating bureaus, and trade union officers are also included (ASOBAT, 1966, pp. 20-21). The

Statement advocates that “accounting information is the chief means of reducing the uncertainty

23

under which external users act as well as a primary means of reporting on stewardship”

(ASOBAT, 1966, p. 19).

The conceptual framework for financial accounting and reporting has been considered as

an important source for users of accounting information as it defines objectives, qualitative

characteristics, elements, recognition, measurement, financial statements, earnings, funds flow,

and liquidity. It is a coherent system of interrelated objectives and fundamentals aimed at

establishing the accounting standards and related issues. This framework is indeed the unique

source of reference in accounting and financial reporting as it has been highlighted in the joint

project between the American (Financial Accounting Standard Board-FASB) and international

(International Accounting Standard Board-IASB) standard-setters.

Institutional efforts to develop a conceptual framework in the accounting discipline can be

traced to the Paton and Littleton monograph (1940) and later to two accounting research studies

by Sprouse and Moonitz (1962) and Moonitz (1961). After several institutional attempts to lay

the foundations of a conceptual framework by the AAA in 1936, and the SEC during 1940-1950,

the publication of the ASOBAT (1966) heralded a new era to accounting by redirecting “attention

away from the inherent virtues of asset valuation models and toward the ‘decision usefulness’ of

financial statements” (Zeff 1999, p. 97)9.

The idea of the decision usefulness approach which was originally supported in ASOBAT

was then carried forward into a major report issued by a special study group entitled Trueblood

Committee in 1973. Considered as an initial attempt by professional bodies in the U.S., the

Trueblood Committee stated that “an objective of financial statements is to provide information

useful to investors and creditors for predicting, comparing, and evaluating potential cash flows to

24

them in terms of amount, timing, and related uncertainty” (1973, p. 20). However, the Committee

added that financial statements should “serve primarily those users who have limited authority,

ability, or resources to obtain information and who rely on financial statements as their principal

source of information about an enterprise’s economic activities” (1973, p. 17)10. The Committee

was not also totally negligent with respect to the social role of accounting as it pointed out that

“an objective of financial statements is to report on those activities of the enterprise affecting

society which can be determined and described or measured and which are important to the role

of the enterprise in its social environment” (1973, p. 55)11.

The striking point is that the relative importance given to stakeholder interests and social

environment in earlier reports, particularly in the ASOBAT Report (1966) and the Trueblood

Committee (1973) lost its support and acceptance in the following reports which were later used

as the basis for implementing the U.S. GAAP and IFRS.

In line with the above efforts, the conceptual framework was implemented in 1976 in the

U.S. and since then, despite some minor changes, the body of this framework remains the same.

A Statement of Financial Accounting Concept No. 1 (SFAC 1-FASB 2010) states that the first

objective of financial reporting is to provide information that is useful in making business and

economic decisions. Although the financial information users are divided into ‘internal’ and

‘external’ with reference to various groups of stakeholders, SFAC 1 focuses on existing and

potential investors and creditors as the primary users of accounting information.

The introduction of the Sarbanes-Oxley Act in 2002 in the U.S. did not affect the content

of the framework and its objectives because the Act primarily focused on auditing, board

25

responsibilities, internal control over financial reporting, audit committee and corporate

responsibilities for financial reporting.

Similarly, in the context of the IFRS conceptual framework, “the objective of general-

purpose financial reporting is to provide financial information about the reporting entity that is

useful to existing and potential investors, lenders and other creditors in making decisions about

providing resources to the entity” (IFRS 2011, p.1)12.

We have also conducted a content analysis of the conceptual framework and accounting

standards of the U.S. GAAP, and IFRS. We also analyzed these documents to see if the terms

such as ethics, integrity, or social values are included in the standards. We did not find any

particular reference to stakeholder, public interest, society, and social values.

Evidently, the conceptual framework and the accounting standards, whether in the context

of the U.S. GAAP or IFRS, do not consider the potential of the stakeholder perspective in improving

financial decisions. The conceptual framework which is used as the main source for standard setting is

primarily defined from the economic perspective of accounting rather than the social point of

view. In this framework, the emphasis is clearly made on decision-relevant information from the

viewpoint of major shareholders and creditors.

The question which needs to be investigated in-depth is whether the integration, with

insights, of stakeholder thinking into the accounting conceptual framework and standards

reinforces the quality of the accounting information and contributes to the mitigation of the

problems of information asymmetry and the expectation gap? This issue can be examined as a

further research in empirical or behavioral studies. However, there are a number of research

problems which should be resolved before conducting such studies. We try to raise some of these

concerns in the following question. Above all, a central issue is that there is no consensus on the

26

notion of stakeholder. “Accountants are accountable to whom” and “accountable for what”?

(Roberts and Mahoney, 2004, p. 408)13. Who are the legitimate and who are the derivative

stakeholders? Who should determine the criteria that distinguish important and unimportant

stakeholders? (Sundaram and Inkpen 2004).

In the absence of clear answers to the above questions, how would it be possible to

incorporate the interests of stakeholders in the accounting conceptual framework and standards

upon which the accounting practices and financial reporting are conducted? Some authors use

very general criteria to identify the stakeholders. Van der Laan et al. (2008) identify primary and

secondary stakeholders as the two groups of interest depending on the nature of their

relationships with the firm. “Primary stakeholders are those who have a reciprocal and direct

exchange relationship with the corporation, whereas secondary stakeholders try to influence these

exchange relationships much more indirectly” (2008, p. 302). This definition requires some

clarifications because these relationships are not defined in the same way in a public organization

or corporation in which a state has a big stake, compared to a corporation run by a family

ownership or institutional shareholder. Is the timing of such a relationship taken into account?

For instance, in Van der Lann’s classification (2008), where is the place of potential shareholders

or clients who may have substantial interests in the future of a company, and whose perceptions

may also strongly affect the company’s current performance (e.g., current stock price is affected

by future expectations of potential buyers and sellers) although there are not currently associated

to any relationship with the company?

27

Research Question 3

Considering the concept of the expectation gap, what are the main reasons for the absence or

the shortcomings of stakeholder views in accounting practices and reporting?

Accounting is broadly conceived as the measurement and communication of economic

information relevant to decision-makers and users of this information. Does a gap exist between

what the public expects or needs and what accountants can and should reasonably be expected to

do? This is arguably one of the main issues that has confronted the accounting profession in

recent years. Taking into account the shortcomings expressed by regulatory bodies regarding the

usefulness of financial accounting information and reporting, and the increasing criticisms of

users in this regard, there is evidence of a great disparity between what society expects of

accountants and the perception of users’ information about accounting in general and .

In RQ1 and RQ 2, we have discussed the main reasons ―that are inherently related to

accounting discipline―which may explain the shortcomings or the lack of interest of stakeholder

view in accounting (theoretical literature, statements, conceptual framework, principles and

standards). A thorough examination of the reasons underlined the expectation gap shows that

there are other reasons which may explain the absence of stakeholder thinking particularly in the

context of disclosure of accounting information and financial reporting. In this research question,

we attempt to present an overview of some of the most important issues including poor ethical

climate and ineffective control environment, market pressure and bubble economy,

Accountability and control mechanisms, and alignment between executive compensation package

and shareholders financial interests within organizations.

28

Poor ethical climate and ineffective control environment

Given the preponderance of unethical behavior sweeping corporations, there is clear evidence of

poor ethical climate and the lack of commitments to ethical principles within them. Poor ethical

climate and managerial misconduct do not certainly contribute to the fair treatment of

stakeholders and their access to information because under unfavorable conditions, the main

concern of the board members is to protect their own interests and possibly the interests of the

major financiers.

Similarly, the company’s relationship with stakeholder groups greatly depends on

management decisions. All those who are involved in the firm look to the top for guidance

(Schwartz et al., 2005; Schroeder, 2002). According to Hambrick (2007) if we want to

understand why organizations do the things they do, or why they perform the way they do, we

must consider the biases and dispositions of their most powerful actors―their top executives.

Indeed, the commitment to stakeholders is strongly affected by the manner in which the

company’s board of directors, senior management and CEO perceive their responsibilities in

setting the tone of an organization, the topic which is dealt with ‘tone at the top or control

environment’.

Climate in an organization is defined as perceptions of organizational practices and

procedures that are shared among members (Schneider, 1975). The idea of ethical climate has

been driven from the theory of ethical work climate developed by Victor and Cullen (1987,

1988). Martin and Cullen (2006) stated that there are various types of climates in the workplace

and one of them is the ethical climate, which is related to the established normative systems of

organization.

29

The concept of ‘tone the top’ or ‘control environment’ includes the integrity, ethical

values and competence of the entity’s people; management’s philosophy and operating cycle; the

way management assigns authority and responsibility, and organizes and develops its people; and

the attention and direction provided by the board of directors (COSO, 2004, p. 2)14. The

disclosure of accounting information and financial reporting to various interested parties as well

as the quality of internal control over financial reporting are an integral part of the framework of

control environment. For this reason, the corporation’s response to stakeholders’ demands in the

area of financial reporting depends, to great extent, on the personal values of board members and

particularly the CEO who has the ultimate responsibility in decision-making and in defining the

characteristics of control environment.

Market pressure, bubble economy and quality of accounting information

In a disordered and inefficient financial market resulting from the bubble economy, there would

be naturally the strong effect of market pressure tied to the desire of management of some

publicly listed companies to satisfy the unrealistic expectation of investors and analysts at the

expense of the interests of various stakeholders demanding the high quality accounting

information.

In disordered market conditions oriented towards artificially smoothed earnings, not only

the stakeholders’ interests and their access to fair and objective accounting information would be

jeopardized, there should be a significant gap between the reported accounting information and

the real performance of companies. On several occasions, the management of publicly listed

companies appears to have engaged in a number of creative accounting practices that while 30

technically acceptable, are arguably unrealistic or unethical. Soltani (2007) stated that as share

prices soared in the bubble economy, people pointed to the growing gap between the book value

of companies (what appeared in their accounts) and their market capitalization (value on stock

exchanges) as evidence of the irrelevance of accounts (2007, p. 580).

Accountability and control mechanisms

An appropriate response to stakeholders’ expectations can be found in accountability mechanisms

and having the possibility to question the stewardship abilities of management, their willingness

to implement effective control instruments, a high level of transparency and quality of financial

reporting, as well as an effective cooperation with external auditors and corporate governance

structure. An effective coordination and communicative interaction between the parties involved

would contribute to company’s performance.

Accountability in organizations may be defined as the perceived need to justify or defend

a decision or action to some audience which has potential reward and sanction power, and where

such rewards and sanctions are perceived as contingent on accountability conditions (Frink and

Klimoski 1998). Koppell (2005) proposed a five-part typology of accountability conceptions:

transparency, liability, controllability, responsibility, and responsiveness. It also concerns the

individuals’ perceptions and feelings about their own levels of accountability, and the degree to

which they will be required to answer for others (Royle and Hall, 2012). “After all, it is only

accountability that legitimizes the exercise of any power; because it is the only way to ensure that

the power which has been delegated is not abused that any c

31

between those who delegate the power and those who exercise it are properly resolved” (Monks

1993, p. 167).

Alignment between executive compensation package and the shareholders interests

The recent corporate financial failures raises the question of whether the substantial remuneration

of CEOs or board members is based on criteria such as performance, merit, skill and competence

or is a product of ‘give-and-take’ and arm’s length negotiation between management and

financiers at the expense of other stakeholders’ interests. It is argued that “a financial markets-

based compensation seeks to align the interests of managers with those of shareholders and to

reward the former in a way that is commensurate with their performance” (Desai 2012, pp. 126-

127). Evidently, the direct relationship between the dividend policy based on company’s market

performance, and the management incentives and compensation package may harm the interests

of other stakeholder groups. This may also be one of the sources of conflicts between

management-shareholders and the other interested parties.

CONCLUSIONS

This paper examines the importance of stakeholder thinking in financial accounting and reporting

by analyzing the theoretical literature, the statements of basic accounting theory, as well as the

conceptual framework, principles and standards which serve as the basis of accounting practices.

The study sets out to highlight the conceptual confusion and a number of shortcomings that have

continued to limit the well-shaped relationship between accountants and the potential users of

32

accounting information. The paper attempts to show that without resolving these key issues and

bottlenecks - some of which are related to the structural nature of the capital market economy- it

is highly unlikely that the dialogue could progress further than a normative discussion in

academic literature with no concrete practical outlets.

By formulating three research questions, we have mapped out the central issues that

undermine the importance of stakeholder thinking in financial accounting, both in theory and

practice. From the stakeholder’s point of view, the major ambiguities and confusions come from

the clear definition of the term ‘stakeholder’, its theoretical content and scope, as well as the

objectives and expectations of various groups of stakeholders with respect to accounting

information and financial reporting. Due to significant disparities among the stakeholder groups,

it is evident that they cannot be treated in a similar manner in terms of access to accounting

information on the basis of fairness, transparency and objectivity. There are major differences

between employees and minority shareholders and groups such as potential investors, clients or

suppliers with respect to their commitments to organizational goals. Then, the key question is

who should decide on the acceptable level of information asymmetry and the associated costs.

From the expectation gap perspective in accounting, the question is whether accountants

can reasonably respond to the demands of various interested parties. Considering the current legal

and regulatory framework, particularly with respect to ownership structure and the power and

control exercised by majority shareholders in corporate decisions including the nomination of

board of directors and management, as well as their compensations packages, accountants cannot

do much about this. Indeed, although accountants are in charge of the preparation of accounting

and financial information, the ultimate responsibility remains with management in terms of

33

reporting and disclosure policies, control mechanisms and the choice of accounting methods. The

management assertions and judgements are an integral part of the communication and reporting

policies.

Our theoretical analysis of accounting statements provides evidence that, despite the

existence of socially-oriented objectives and stakeholder views in several official statements

released in the 1960s, the field of accounting has been significantly influenced by market-

oriented indicators and economic income for the benefit of financiers for the last several decades.

Indeed, the field of accounting as a social phenomenon is under-researched and seriously

suffers from deficiencies both in terms of scope and objectives as well as the research direction.

This observation is supported by our analysis of the conceptual framework and principles which

are used as the main guidelines in accounting and reporting practices. To create a complementary

discussion with respect to possible ways to close the gap between stakeholders’ demands and

accounting, we raised a number of issues including the ethical climates within organization and

the market economy, the control environment, the bubble economy, market pressure and earnings

management, accountability and financial-markets-based compensation for management.

This paper contributes to the academic literature as it attempts to refocus and re-centre the

discussion around certain key issues regarding accounting and stakeholder interaction. It has

practical implications for regulatory bodies and accounting standard-setters seeking to reinforce

public trust and confidence by responding in a more effective manner to the legitimate demands

of various stakeholder groups for high quality accounting information and reporting

Overall, we believe that the different analyses presented in this study provide potential

contributions to the better understanding of the root causes of the failure of stakeholder-

34

accounting interaction. Although this study examines this relationship in a broader context,

further research can explore other areas of interest such as the institutional and regulatory

frameworks which help to reinforcing this interaction, the problems associated with disparate

goals and objectives among stakeholders and how these may affect their demands for accounting

information, effective means of communication policy and control mechanisms which assure the

fair access of all interested parties to information and the ethical considerations involved in

accounting and stakeholder relationships.

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1 Emphases are ours.

2 Emphases are ours.

3 Emphases are ours.

4 Emphases are ours.

5 Emphases are ours.

6 Emphases are ours.

7 Emphases are ours.

8 Emphases are ours.

9 The study of Zeff provides an extensive review of the evolution of the conceptual framework until the 1990s.

10 Emphases are ours.

11 Emphases are ours.

12 Emphases are ours.

13 Emphases are ours.

14 Emphases are ours.

42

Liste des cahiers de recherche du PRISM – ANNEE 2015

N° Titre Auteurs

CR-15-01 La culture et la confiance comme déterminants de l’efficacité d’une collaboration : le cas AIR France - KLM

Cindy VAN DEN BERG Anne GRATACAP Alice LE FLANCHEC

CR-15-02 Equity Crowdfunding : Amplificateur de la responsabilité sociale

Marina MILOSEVIC

CR-15-03 Estime de soi du consommateur : vers une clarification du concept et de sa mesure

Anne BONTOUR

CR-15-04 Importance of Stakeholder Thinking in Financial Accounting and Reporting –Analysis of the Reasons of Shortcomings in this Relationship

Braham SOLTANI