By Alan Murray and John Kell
April 14, 2017

Good Friday morning.

Take some time this weekend to read this interesting new piece in the Harvard Business Review entitled “The Error at the Heart of Corporate Leadership,” by professors Joseph Bower and Lynn Paine. They argue that the concept of shareholders as “owners” of the corporation—which they trace back to the 1976 article on The Theory of the Firm by Michael Jensen and William Meckling—is legally confused, fundamentally wrong, and damaging to society. Shareholders have no legal duty to protect or serve the companies whose shares they own, they are shielded from legal responsibility for corporate misdeeds, and they often hold shares for only days or even minutes—so how can they be expected to act as true owners? Yet over the last four decades, we have developed a system of corporate governance that makes “maximizing shareholder value” an outsized goal.

To demonstrate the damage this approach has done to the corporation, the authors harken back to the classic Boston Consulting Group growth matrix, which divided divisions of the company into “cash cows,” “stars,” “dogs,” and “bright prospects.” Good corporate management meant a careful combination of maintaining the cash cows, funding the stars, pruning the dogs, and choosing a limited number of bright prospects to invest in for the future.

But today’s shareholder focus has led to a new approach, championed by activist shareholders, where the goal has been to sell off the dogs, defund the bright prospects, cut long-term R&D and thus dramatically increase short-term earnings—often at the expense of long-term growth. This puts the focus not on “value creation,” they argue, but rather “value transfer”—from future shareholders to present. “The potential damage to the company and future shareholders, not to mention society more broadly, can easily go unnoticed.”

How can the system be fixed? Bower and Paine argue for staggered board terms—criticized by some as a tool for protecting entrenched management—as a means of ensuring continuity and limiting the excesses of shareholder democracy. They also say boards need to become more active in succession planning and long-term strategy. And they argue for a new approach to corporate compensation, that’s less directly tied to share prices and more connected to strategic goals.

I’m sure plenty of CEO Daily readers will find fault with Bower and Paine’s analysis. But at a time when capitalism is increasingly under attack, it’s worth asking whether the system has taken a fundamentally wrong turn.

News below.

Alan Murray
@alansmurray
alan.murray@fortune.com

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