Morningstar's 2009 CEO of the Year

After 15-plus years analyzing companies, I've become pretty cynical about corporate governance in general and executive compensation in particular. In theory, shareholders and boards should act as checks on executives' authority--but in practice, boardroom revolts are about as common as Miami snowstorms. (Shareholder activism is becoming slightly more common, though.)

In theory, executives are paid for allocating capital intelligently and increasing the value of the enterprise--but in practice, executive compensation schemes are frequently so filled with perks, loopholes, and various "heads-I-win-tails-you-lose" policies that top managers often get paid regardless of how well the company does. Sadly, theory and practice are all too often light years apart when it comes to how companies are managed and how managers are paid.

There are, however, notable exceptions to this generally uninspiring picture, and those are what we try to highlight each year in our CEO of the Year Award. Past winners have included superstars such as Jamie Dimon and Warren Buffett, and lesser-known but no less worthy CEOs such as Robert Silberman of  Strayer Education (STRA) and Will Oberton of  Fastenal (FAST).

This year, we're again going the road-less-traveled route in choosing Mark Miller of  Stericycle (SRCL) for the award. (Click here to see all the nominees.)

Stericycle has grown by leaps and bounds to become the largest medical-waste disposal firm in the country, and we think the company has created a wide economic moat around itself. Onerous regulatory requirements governing the proper disposal of medical waste deter potential competitors, and Stericycle's national scale and regional route density give it a meaningful cost advantage over smaller players.

When Miller joined the three-year-old Stericycle in 1992, the company was bleeding cash and had only 12 customers. With only one month's cash balance left, Miller took a 50% pay cut, mortgaged his home, and cashed out his retirement account to make payroll.

To build the company into its current $1 billion in revenue size, Miller bundled traditional medical waste disposal services with expanded offerings like OSHA compliance training, safety product sales, and pharmaceutical recall and retrieval services. Stericycle also shifted its focus from large hospital customers to smaller, higher-margin customers. This approach has paid off in spades, with earnings and revenue compounding at about 30% annually over the past decade, solid returns on capital, and free cash flow currently running at about 15% of sales.

The company's strong financial performance has paid off rather nicely for shareholders, with Stericycle shares compounding at a smidge less than 28% annually over the past decade. Interestingly, this phenomenal performance has been driven largely by growth in earnings and cash flow, rather than a big change in the shares' valuation--Stericycle's price-to-earnings ratio has been fairly steady over the past decade. And although a large portion of Stericycle's growth has come from over 170 acquisitions, it's avoided the pitfall of many acquisition-hungry companies by integrating them well, as evidenced by the company's consistently high margins and returns on capital.

We like Stericycle's approach to corporate stewardship as well. Executives receive a majority of salary in the form of stock and other long-term incentives, and all executives are required to have equity ownership equal to 3-5 times their base salary, dependent on years of service. In fact, Stericycle's compensation structure is so focused on long-term value creation and long-dated incentives that 2008 was the first time in five years that executives received increases in base salaries--and only 3% at that.

The company is a regular grantor of stock options to both executives and board members, and allows executives to take their annual bonus in options rather than in cash. (Board members get the same option for their annual retainer.) Though we frown on egregious option issuance, Stericycle explicitly aims to keep annual dilution at 2% or less, and in our opinion, it has been using options for their original purpose--encouraging long-term value creation--rather than for lining executives' pockets with lottery tickets, as is the case for many companies. Stericycle has spent almost $500 million buying back shares since 2004, and has generally done so toward the lower end of the shares' annual range. This is a pleasant trend to see, since it indicates that management is thinking about share repurchases as purposeful investments of corporate capital, rather than as a mindless attempt to sop up option-related dilution.

Finally, Stericycle has no golden parachutes, no extraneous perks paid for by the company, and no lucrative executive retirement plans. Compensation is clean and simple, and rewards executives solely for creating wealth for shareholders. If only more companies followed the same example.