According to Deegan and Unerman (2006, 271), legitimacy theory asserts that organizations continually seek to ensure that they are perceived as operating within the bounds and norms of their respective societies, that is, they attempt to ensure that their activities are perceived by outside parties as being ‘legitimate’.
Legitimacy theory relies upon the conception of a ‘social contract’ between the organization and the society in which it operates. “The concept is used to represent the multitude of implicit and explicit expectations that society has about in which way the organization should conduct its operations” (Deegan and Unerman, 2006, 271).
Deegan and Unerman (2006, 272) assert that legitimacy from society’s perspective and the right to operate go hand in hand. Society allows the organization to continue operations to the extent that it generally meets their expectations. Legitimacy theory predicts that management will adopt particular strategies to assure the society that the organization is complying with the society’s values and norms, for example the disclosure of information in annual reports.
Legitimacy theory is one example of many theoretical perspectives, adopted in explaining and predicting accounting practice. Even though this research is about audit services and the audit report, it is worth considering the legitimacy theory. The essence is about information disclosure, accountability, value relevance and the information needs of users. Legitimacy theory could also be signaled as an explanation of the need for an independent opinion on the truth and on the fairness of the company’s’ reporting.
According to Donaldson and Davis (1991, 51), stewardship theory holds that there is no inherent, general problem of executive motivation. “The executive manager, under this theory, far from being an opportunistic shirker, essentially wants to do a good job, to be a good steward of the corporate assets.”
According to stewardship theory, performance variations arise, not from inner motivational problems among executives, but from whether the structural situation in which the executive is located facilitates effective action by the executive (Donaldson and Davis, 1991, 51).
Donaldson and Davis (1991, 52) pretend that stewardship theory focuses not on motivation of the CEO but rather facilitative, empowering structures. Contrary to the agency theory, stewardship theory holds that fusion of the roles of CEO (executive management) and chair of the board of directors will enhance effectiveness and produce superior returns to shareholders than separation of the roles of CEO and chair.
“Agency theory provides a useful way of explaining relationships where the parties’ interests are at odds and can be brought more into alignment through proper monitoring and a well-planned compensation system” (Davis et al., 1997, 24). According to the authors however, to explain other types of human behavior, additional theory is needed.
Following Davis et al. (1997, 21), in stewardship theory, the model of man is based on a steward whose behavior is ordered such that pro-organizational, collectivistic behaviors have higher utility than individualistic, self-serving behaviors. The stewardship theory defines situations in which managers are not motivated by individual goals. They are rather stewards whose motives with the objectives of their principals are aligned.
“Stewardship theorists assume a strong relationship between the success of the organization and the principal’s satisfaction. A steward protects and maximizes shareholders’ wealth through firm performance, because, by so doing, the steward’s utility functions are maximized” (Davis et al., 1997, 25).
Stewards are motivated by intrinsic rewards, such as reciprocity and mission alignment, rather than solely extrinsic rewards. The steward, as opposed to the agent, places greater value on collective rather than individual goals; the steward understands the company’s success as his own achievement.
According to Davis et al. (1997, 37), the primary difference between agency theory and stewardship theory lies in the assumptions about human nature. According to the agency theory, people are individualistic, utility maximizers. According to stewardship theory, people are collective self-actualizers who achieve utility through organizational achievement. Davis et al. summarize the main differences between the two theories as presented in figure 2.