How to Gauge a C.E.O.’s Value? Hint: It’s Not the Share Price

Everybody knows that chief executives receive bounteous pay as a matter of course. Less discernible, though, is who actually earned their pay the most by increasing the value of the companies they run by a commensurate amount. Such performers are not to be confused with executives who work to propel their company’s stock price.

The most common performance metrics used by companies can be problematic. Total shareholder return, according to a recent study by Equilar, a compensation analysis firm in Redwood City, Calif., is the single most popular measure related to pay at big public companies. Companies love total shareholder return in part because it is easy to calculate. But a company’s stock can rocket even when its operations are being run into the ground. So basing pay on total shareholder return can encourage an executive to manage more for a company’s share price than for its overall health.

A better way to measure whether a C.E.O. has created value at a company is to look at its return on capital over a period of years. This reveals how effectively a company is using its own money to generate profit in its operations. When you compare these returns to an executive’s compensation, you see where pay is justified and where it isn’t.

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