Furor over bankers’ pay has once again put a critical spotlight on executive compensation, but the problems aren’t limited to the financial sector, according to a recent study by The Boston Consulting Group (BCG).

BCG’s analysis of changes in CEO compensation between 2007 and 2008 at 158 companies with more than $5 billion in revenues nationwide found a widespread disconnect between top executive pay and company performance.

Nearly all the companies studied (94 percent) had negative total shareholder return (TSR) in 2008, and, as one would expect, the average level of CEO pay declined from the previous year. About 40 percent of those companies with negative TSR, however, actually paid their CEOs more in 2008 than they did in 2007, the report found.

The BCG report, "Fixing What’s Wrong with Executive Compensation," argues that in order to solve the problem, it’s not enough simply to renew demands that companies "pay for performance."

"The idea of paying for performance isn’t new," said Gerry Hansell, senior partner and managing director in BCG’s Chicago office and a co-author of the report. "The very compensation systems that many criticize today are the product of nearly two decades of efforts to achieve precisely that goal."

To address these shortcomings, the report describes five principles to help the redesign of executive pay systems:

• Emphasize the long term. Incentive compensation plans should have a bias toward the long term in the form of longer vesting periods and multi-year performance targets.
• Reward relative performance. Performance metrics for equity-based compensation should be based on relative, not absolute, performance by indexing a company’s performance to that of a designated peer group.
• Measure performance that executives can directly influence. In general, executives at the business unit level should be evaluated according to financial and operational performance metrics that are relevant to the units they head.
• Focus on value creation, not just earnings or the P&L statement. Internal performance metrics should take into account how executives use the capital entrusted to them by holding them accountable for the size and sustainability of the cash flows they generate after reinvestment.
• Minimize asymmetries of risk. In addition to allowing executives to enjoy the benefits of a potential upside, an effective incentive-compensation system must also ensure that they suffer the costs of potential downside by putting some portion of their own wealth at risk.