ROE v. Paid: Which CEOs Earn Their Keep?

The Conference Board's Peck and others anticipate reforms will take hold, especially in the form of options-based compensation.

"What I anticipate is more judicious use of stock options," Peck said. "What I think you'll see is a trend away from heavy utilization of stock options and a turn to what they call full-value stock -- moving to restricted stock that they have to earn by performance over a three- to five-year period."

Companies may also base compensation on a variety of measures beyond stock performance, including profitability, long-term growth and, yes, return on equity.

In the meantime, investors would be well-served to pay closer attention not only to executive compensation, but also valuation measures such as return on equity.

"With return on equity, basically, you're looking for companies who can earn in excess of their cost of capital," said Rich Eisinger, co-manager of the Mosaic Mid-Cap fund. "If you can fill a portfolio with those guys, you're going to have a winning return."

Of course, our ROE v. Paid list isn't without its anomalies. If a company, because of quirks in its reported earnings, has one blowout year on ROE, it inflates its five-year average. (Dow Jones(DJ), for instance, had ROE of 557% in 2002, which skews its results -- many investors in the long-suffering stock might take exception with CEO Peter Kann's high ROE ranking.) Nonetheless, in general, the five-year ROE is a solid barometer for gauging how a company uses its shareholders' money.

Which brings us back to Buffett. Eisinger cited something Warren Buffett said at his conference over the weekend: Look for companies where the management is in love with the business and not the money. Eisinger cites one stock, too small for the S&P 500, that fits this bill: Fastenal(FAST), a Winona, Minn.-based industrial goods company run by Bob Kierlin. Kierlin pays himself about $100,000 a year, and any stock options the company grants come out of his personal holdings. "You won't find that often," Eisinger said.

Fastenal, by the way, has a five-year average return on equity of 22.6%. Maybe Buffett and followers like Eisinger are onto something.

Stay tuned for sector-by-sector rankings of corporate chieftains by return on equity over the next week. We'll conclude the series with a look at the Best and Worst CEOs according to ROE v. Paid.

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