Is It Safe? Chesapeake Overpays, Loses Big

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Chesapeake Energy(CHK Quote) has come under fire recently for the lavish bonus paid to Chief Executive Aubrey McClendon. His $112.5 million pay package in 2008 was the largest paid to any S&P 500 CEO and has brought about legal action by shareholders.

While this compensation package is outrageous, it's not the only factor that should make investors wary of the gas producer.

Excessive pay on its own usually isn't enough of a reason to rule out a company. However, it's a symptom of an overarching problem that can lead to poor stock performance in the long run.

When a company pays large sums of money to executives rather than invest in its operations, it reflects a fundamental breakdown in the relationship between the firm's owners, the shareholders, and the managers hired to generate returns. While the negative effects of poor corporate governance aren't always immediately apparent, studies have shown that firms with strong board leadership tend to outperform their peers.

Oklahoma City-based Chesapeake has risen 38% this year, outpacing the 1.1% return of the S&P 500 Energy Index. However, rising energy prices have lifted all boats, and some of Chesapeake's competitors have delivered even better gains. Southwestern Energy(SWN Quote), for example, has advanced 45% this year with a stronger return on equity than that of Chesapeake.

At 5.1%, Chesapeake's return on equity is less than a quarter of the industry average of 21%. Bigger firms like Exxon Mobil (XOM Quote), Chevron(CVX Quote) and Schlumberger(SLB Quote) offer returns on equity in excess of 29%.