(FORTUNE Magazine) – A funny thing happened these past few years to the American corporation as it was well on its way to the global hegemony once divined for it by the French pundit Jean-Jacques Servan-Schreiber: It got turned upside down. Whereas its performance once determined the value of its shares, the value of its shares now determines its performance -- indeed its very existence. The reason for this switch lies in a totally false interpretation, fostered by American courts, of the purpose of incorporation. The justification for incorporation was and is that, just as Adam Smith's pin factory gains in efficiency from its famous division of labor, the enterprise gains strength from the legal differentiation of roles. There is a segregation of the rights and liabilities of all those who are affected -- shareholders, creditors, labor, investors, management, suppliers, customers, the community and state. Resources are pooled, and from their skillful orchestration, products and services are created with a greater value than the resources had by themselves. The role of management is just this: to devise the greatest possible value from the financial, human, and technological resources employed in the business. If a better product fetches a higher price or increases demand, it should be made -- otherwise it should not. Unfortunately, Adam Smith's vision has been jettisoned in favor of one for enhancing the wealth of the shareholders. And where do shareholders realize their wealth? Surely not from silly dividends -- their share of the corporation's efforts. They get it from the fabulous gains offered by the financial markets. If only management could be coerced into shouldering a new duty, that of paying attention not to what the corporation makes and sells, but rather to the price of the stock. From now on, the hell with the profits of the corporation, the hell with return on assets, the hell with productivity; what matters is the profits of shareholders -- that is to say, share prices. Management's duty is not to enhance the value of resources employed, but, as the euphemism has it, to enhance shareholder value. AND SO a doctrine was born that in effect imposes on management and the board of directors a fiduciary duty to the shareholders to make them rich, rather like the medieval doctrine of fealty between the vassal and his lord. Since a fiduciary cannot have a conflicting duty to anyone else, it follows that this doctrine requires the board and the management to subordinate the interests of everyone else -- bondholders, labor, research and development, the environment, and sadly, the nation. Although never explicitly acknowledged, the heart of this theory is that shareholders have a virtually unlimited right to enrich themselves at the expense of all others. The law used to be clear that the duty of corporate directors was to further the best interests of the corporation, and there was a clear distinction between owing duties to the company and owing duties to shareholders. There still is in all industrialized countries except the U.S. What happened is that American courts imported without legislative support the concept of fiduciary duty from the law of trusts and estates. They transformed directors into trustees owing a special duty to shareholders. The recent decision by the Chancery Court of Delaware supporting directors of Time Inc., parent of FORTUNE's publisher, in going ahead with the acquisition of Warner Communications is a small step in the right direction. Much more must be done, however, because the idea that directors are trustees is a heresy. There is no economic, moral, or philosophical reason for this leap unless one believes that the essence of free enterprise lies not in the creative genius of freely functioning enterprises but rather in the profits to be derived from the purchase and sale of their shares. None of our industrial competitors have subscribed to such a view; to do so would mean that the stock market is not a means to allocate capital to productive use but an end unto itself. And indeed, this is just what has happened. In less than two decades we have lost our ability to compete internationally in many major manufacturing sectors -- machine tools, electronics, automobiles, you name it -- many of them sacrificed on the altar of enhancing shareholder value. American productivity is sadly lagging while shareholders and their agents are realizing unprecedented wealth. NO JAPANESE or German jurist would arrogate such extravagant rights to shareholders. And why should they? Is the contribution that shareholders make to the successful corporation really so extraordinary? Is the slavish deference accorded them the indispensable cornerstone of a free enterprise system? I think not. The answer some give is that the shareholders have such rights because they are the ''owners'' of the corporation, but does the tenant owe a fiduciary duty to his landlord? Is the tenant required to ensure that real estate prices go up? Of course not -- and the analogy is not as far-fetched as it might sound: In essence the managers and directors of a company are the tenants of that organization, and like other tenants have some rights of occupancy and cannot be thrown out or unduly interfered with before the lease is up. But there is an even more devastating reason for not taking this ownership argument seriously -- in most cases it is simply untrue. The difference between U.S. and Japanese practice was made startlingly clear recently when T. Boone Pickens, determined to look ridiculous, demanded that in light of his acquisition of 20.2% of the shares of the Koito Manufacturing Co. of Japan, he should be permitted to put three of his people on the company's board. His advances were rejected, and rightly so, on the ground that a minority stake doesn't carry with it the right of representation. Not surprisingly, those who most vociferously argue for unbridled shareholder rights are usually playing with someone else's cash. In view of the debt incurred to purchase shares, a raider's nominees could hardly be expected to represent the best interests of a corporation. Without the right to tear the company apart, how could they retire the debt and realize a profit? A sane corporate law would require the board and management to operate the enterprise without regard to the stock market. It would prohibit boards from having anything to do with, let alone participate in, the public auctioning of corporations. It would permit shareholders to remove directors but not to sue them except for moral turpitude. It would altogether eliminate the absurd notion of ''derivative'' lawsuits (suits by shareholders on behalf of the corporation against management and directors). It would not permit corporations to buy their own shares and thereby give rise to greenmail, these things being unknown outside the American system. And it would provide for a voice on takeovers -- hostile or friendly -- to all who have an economic stake in the outcome. BESIDES being aggregations of property, things people own and buy and sell, corporations are social organisms, the theater in which men and women realize or fail to realize purposeful and productive lives; their effectiveness and productivity are perhaps the most important barometers of the effectiveness and productivity of a nation. A measure of the grotesque distortions in our corporate law is that the two effective devices sanctioned by the courts so far for the defense of corporations, the poison pill (a change in the structure of a company activated by a takeover to make the company less attractive to any new owners) and the ESOP lockup (putting shares in a management-friendly employee stock- ownership plan), rest on the principle of setting one group of shareholders against another, thereby making a takeover either uneconomical or impossible. Since the courts have given shareholders such vast destructive powers, the only solution is to fight fire with fire, to create another group of shareholders with equally vast power. But neither the poison pill nor the ESOP lockup helps to bring shareholder rights into constructive proportion with the rights of other participants in corporate life, and both have potentially deleterious effects on future capital costs, the price at which the corporation can raise new equity. And that, after all, is why the overstating of shareholder rights is such a basic attack on the capitalist system.