7101AFE S2 2016: Week 5 Workshop Solution

1. An externality is a consequence of an economic activity on unrelated third

parties. This consequence on third parties is not reflected in the pricing
mechanism. An externality can be a positive experience or a negative
experience.

Corporations are living systems that operate within the larger system of a
society. Not every member of the society participates in the economic activities
of a specific corporation. CSR is about a corporation being accountable to its
broader society in which it operates. Corporate activities often degrade natural
and social environments and these in turn affect unrelated third parties. Thus,
CSR is about being accountable for these externalities.

2.

A social contract is a contract between an organisation and the society in which

the organisation operates. The social contract has explicit and implicit
components. The implicit component comes from the tradition, norms, values,
and culture of a society. The explicit component comes from the laws of the land.

Legitimacy theory is premised on the notion of social contract. Legitimacy theory

posits that if a firm is found to have breached its social contract, the firm loses
its legitimacy to operate in that society. Loss of legitimacy can be costly for a
firm in terms of product boycott by customers, withdrawal of support from
suppliers, new regulation or sanction. Thus, it is very important for a firm to
maintain its social legitimacy.

3.

Legitimacy Theory Stakeholder Theory

Legitimacy theory is premised on the Stakeholder theory is premised on the
notion of social contract and refers to notion that there are several
the whole society in explaining firms stakeholders in a society competing for
reactions to legitimacy gap. greater share of wealth and income.
It refers to the society as a whole. It refers to different stakeholders in a
society.
It is empirically testable. Ethical branch of the stakeholder
theory is not testable.

4. The business entity has to assess its potential sources of legitimacy threats.
Once it identifies a legitimacy gap, the entity has to take proactive measures in
addressing the legitimacy gap. This might include changes in the product or
service to meet community expectations and improved corporate disclosure to
relevant stakeholder groups.

5. A business entity can make improved corporate disclosure to communicate

how it responded to legitimacy gap. It might try to change the notion of social
legitimacy. The entity may also change the process and structure of the product
or service to meet community expectations.

6. Institutional theory considers the forms organisations in a particular industry

or sector and provides explanations as why organisations take similar form and
characteristics. It provides a complementary perspective to Legitimacy theory
and Stakeholder theory.

There are three processes of isomorphism:

Mimetic isomorphism refers to the process of one organisation copying the

practice, process, and structure of other successful organisations. For example, if
a firm is found to have improved their market share by improving CSR disclosure
then other firms in the same industry will tend to make greater disclosure of their
CSR activities.

Coercive isomorphism takes place when a firm adopts a certain practice, process
or structure due to coercion or pressure of a stakeholder group. For example, a
firm might disclose more on its environmental performance because of
shareholder pressure.

Normative isomorphism refers to the adoption of a new practice, process, or

structure because that is expected or common in a particular industry or sector.
For example, accountants are expected to follow professional codes if they are
members of a professional body.

7. CSR reporting is reporting about the corporate environmental, social and

human development performance of an entity. The long-run sustainability of a
firm depends on the support of the society in which it operates. Because
negative externalities related to firm operations (e.g., environmental pollution)
give rise to legitimacy gap, maintaining social legitimacy is vital for a firms
economic sustainability or performance. CSR reporting and performance are also
likely to be related because firms with superior financial performance are more
likely to engage more in CSR activities. There is also research evidence to
suggest that CSR reporting is related to performance of an entity. For example,
Cochran and Wood (1984) and McGuire et al. (1988) provide evidence that CSR
performance is related to financial performance of a firm.

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