Our 2008 CEO of the Year Nominees

Choosing a CEO of the Year after the most dismal 12 months in recent financial history is a bit tricky. Most of the industries that did well in 2008--discount retailing and for-profit education, for example--did so because they're countercyclical, not by dint of any superhuman managerial effort.

Jamie Dimon came to mind, as head of one of the few big banks to (largely) sidestep the credit mess--but we named him CEO of the Year for 2002 when he was still heading up Bank One. Steve Ballmer's name was also floated, since he's done a decent job of running Microsoft since Bill Gates moved on, but Ballmer's pointless and potentially expensive pursuit of Yahoo in 2008 took him out of the running. In the end, we settled on four candidates--three of which, interestingly enough, are from the embattled financial-services sector.

Robert Kotick,  Activision Blizzard 
I'll start with the one candidate from outside the financial sector, Robert Kotick from Activision. If you had invested $10,000 exactly 10 years ago in Activision, you would have about $100,000 today, even after the stock has been cut in half this year. This obviously far outpaces the S&P 500, which has been essentially flat for the last decade, and the person largely responsible for your good fortune is longtime CEO Kotick.

Ever since Kotick purchased a controlling interest in Activision in 1990, his goal has been to build the world's leading video game company. He achieved that goal this past year as Activision Blizzard overtook rival  Electronic Arts (ERTS) on the back of massive hits like Guitar Hero and Call of Duty. In addition, Kotick engineered a transformational merger with Blizzard Games, the makers of the ubiquitous World of Warcraft. Kotick spent a year laying the groundwork for the Blizzard acquisition, and when the deal was struck, the math showed that Activision shareholders got a Ferrari for a Chevy price. Activision has a long history of successful acquisitions because Kotick remembers what most managers in hot pursuit forget: The return you earn is dependent on the price you pay. Kotick has been quoted as saying return on invested capital is the only objective measure of a company's value, and we wholeheartedly agree.

The proof of Kotick's success is in the numbers. During the past 12 months, Activision has posted an operating margin of 17%, while Electronic Arts has posted an operating loss. Over the past 18 years, Kotick has built Activision from an empty shell he and a partner purchased out of bankruptcy for $500,000 into a $12 billion market cap company that is the class of the field.

John Allison,  BB&T (BBT)
It may seem odd to nominate a bank CEO after all the trouble that imprudent lending has caused to our financial system, but John Allison, BB&T's retiring CEO, is a worthy candidate. During his tenure, he has used the combination of conservative underwriting with timely expansion to create a Southeast banking giant. With an intense focus on culture, Allison's personality and ethics are ingrained throughout the organization.

Allison's conservatism shined strongly in the past year's dismal banking environment. While BB&T has not been immune to the problems, its strong capital position and underwriting standards have helped tremendously. In the first nine months of 2008, earnings declined only 9% from the same period in 2007, and in a landscape of dividend cuts, Allison actually increased BB&T's dividend slightly.

BB&T could post these kind of results because losses at its peers were 50% higher than BB&T's. The bank's resilience has largely come from Allison's ability to portray BB&T as a safe haven for its customers, helping the bank to soak up deposits and profitable small and mid-sized business clients from its troubled peers at a rapid rate, as well as Allison's long-term efforts to enter the insurance brokerage business, which now accounts for 14.5% of total revenues. Most important of all, Allison's focus on the company's culture and his close relationship with his fellow managers have assured us that even though he will retire at the end of the year, BB&T's conservatism will remain its backbone and, we believe, will help reward shareholders for years to come.

Tom Lewis,  Realty Income (O)
Tom Lewis runs Realty Income with just one thing on his mind: dividends. Unique even among REITs, Realty Income doles out cash monthly, and maintaining and growing these shareholder paychecks govern every decision the firm makes. Lewis didn't invent Realty Income's business model, which predates his 1987 hiring by nearly two decades, but he's done a phenomenal job executing and refining a low-risk strategy while deepening the cultural imperative of dividends through the ranks. There's no flab at corporate headquarters; squeaky-clean governance practices earn our "A" Stewardship Grade, and with equity incentive awards made in dividend-paying restricted stock (rather than non-paying options), management is directly invested in stable and growing dividend payments

As he described in an outstanding shareholder letter in the firm's 2007 annual report, preservation of capital and income are paramount. Lewis chairs the firm's investment committee, in which he and his senior lieutenants personally approve each and every building that is purchased for the firm's portfolio of freestanding, single-tenant retail properties. Moreover, none of the exotic financial structures that other REITs have employed can be seen on Realty Income's balance sheet, which is solidly funded with equity and a modest amount of long-term debt. Realty Income may be out of favor when riskier stocks are in fashion, but even in this historically turbulent year for REITs, Realty Income has continued to reward investors with five separate dividend increases in 2008 and a share price that has substantially outperformed both its industry and the broader equity markets.

Since Lewis took the helm in 1997, per-share dividends have grown a bit over 5% annually, and with a yield typically in the 7% range (7.4% today), shareholders have earned solid total returns without taking much risk. A hundred shares purchased when Lewis became CEO would have cost $1,263. Those shares are now worth $2,302 and have paid $1,443 worth of dividends along the way.

 Warren Buffett,  Berkshire Hathaway (BRK.B)
Buffett's story is a well-told one--a phenomenal record of shareholder value creation, a modest paycheck, and exemplary corporate governance--so I'll focus on the reasons why he's a nominee for 2008 in particular. (A few years ago, one of my colleagues jested that Buffett should be CEO of the Year every year.)

First, Buffett had long ago warned about the dangers of misusing derivatives, and those chickens finally came home to roost in 2008 when investors discovered how instruments designed to mitigate risk can actually magnify it when they're not properly understood or accounted for. For example, AIG wouldn't currently be in de facto government receivership if its risk managers had understood that the company's financial products unit was picking up pennies in front of steamrollers. Six months ago, most knowledgeable financial professionals would have laughed at the idea that poorly used derivative instruments could bring down the world's largest--and AAA-rated--insurance company. But they did.

Second, 2008 was the year when Buffett finally deployed a sizable chunk of the cash that had been building up on Berkshire's balance sheet. Buffett had always been clear that the cash was building up due to a lack of decent investment opportunities, and in 2008, he saw enough attractive opportunities to put much of it to work.

While the rest of the world was gorging on cheap credit over the past several years, Buffett maintained Berkshire Hathaway's conservative financial profile. Although this hindered Berkshire's returns when times were good, having lots of cash on hand enabled Buffett to snap up once-in-a-lifetime deals after the storm clouds rolled in and the credit markets seized up. When liquidity is scarce, those who have capital can call the shots.

The 2008 CEO of the Year winner will be announced on Morningstar and CNBC on Wednesday morning, Jan. 7, 2009.