“To many, the recent corporate scandals are a direct consequence of widespread greed. Managers and their lawyers, investment bankers and accountants simply lied to investors for their own avaricious gain,” wrties Jeff Madrick in today’s New York Times.

“But the root of the problem was not just human nature. It also resulted from a widely accepted economic theory about how to create incentives to govern a business.”

“Most of us have heard the argument. The overriding objective of a company’s management should be to maximize shareholder value — that is, keep the stock price rising.”

“For Lynn Sharp Paine, a professor of business ethics at Harvard Business School, the single-minded attention to such priorities was at the heart of the recent problems. Concentrating on financial goals alone often led managers to abuse or neglect other areas, like product quality or research. In a new book, Value Shift ( McGraw-Hill, 2002), she writes, ‘In almost 20 years as a business academic, I have rarely heard anyone question this conception of performance, so deeply imbedded is it in conventional thinking.’ “

“But the principal flaw of the prevailing theory may actually be a financial one. The modern theory typically depends on the idealized efficient-markets theory, which asserts that at any given moment the stock price is not only the best measure we have of the future value of a company, but usually an accurate one. The stock price will thus send the right signals to reward appropriate managerial behavior.”

“It says something about the intramural vitality of the Harvard Business School that the most influential proponent of this view is Ms. Paine’s colleague, Michael C. Jensen, now an emeritus professor. His second-year M.B.A. course was one of the most popular at the school.”

“Mr. Jensen’s academic roots were in efficient-markets theory. The price of a stock, the theory goes, quickly incorporates everything publicly known about a company. As Robert J. Shiller put it in his book Irrational Exuberance (Princeton University Press, 2000), ‘Prices may appear too high or too low at times, but, according to efficient-markets theory, this appearance must be an illusion.’ “

“This may sound preposterous to some, but at least a modest version of the theory is supported by solid academic research. For example, if stock prices were obviously mispriced, it would be easy for trained professionals to beat the market. But the research shows that few can. Arguably, stock prices at least sometimes reflect a company’s true value.”