Pay practices that indicate excessive appetite for risk, poor relationship between pay and performance, and companies' inabilities to use sound performance measures when determining executive compensation are some of the reasons why more than one-fifth of S&P 500 companies get a failing grade in their executive compensation scorecards. In the inaugural study compiled by executive compensation research firm, Governance Metrics International, 102 companies out of 456 companies in the S&P 500 group were rated as high-concern companies based on their pay practices.

Topping the list of worst scoring companies on GMI's scorecards are Abercrombie & Fitch, Moody's Corp., Aetna, Nabors Industries, Medtronic, Zimmer Holdings, Prudential Financial, Constellations Brands, Teradyne, and Yahoo!

According to Paul Hodgson, chief communications officer at GMI, companies which scored poorly on their survey have a common link, “Poor relationship between pay and performance, either through a straight disconnect or abnormally high levels of non-performance related pay,” he says. He adds the seeming inability of companies only to pay incentives when a company has outperformed its peers is virtually economy wide rather than industry wide.

GMI's scorecards utilized ten compensation governance tests to help identify outliers companies in terms of their pay practices. The metrics used are largely focused on incentive compensation policies that gauge the effective alignment between CEO compensation and company performance. Also incorporated into the study are the internal pay equity metric and an assessment of key fixed pay elements. The firm said its analysis is derived from information obtained from companies' proxy statements filed on or after Jan. 1, 2011.

Hodgson says effective compensation is not only considered necessary to incentivize executives to create value for investors, it is also an indication of the appetite for risk at a company. “Through the scorecards, we flag a poor practice at a company, regardless of whether it is an industry-wide issue, such as the size and structure of executive pay packages in the financial sector which encouraged excessively risky decisions that pushed the markets to the brink of disaster in 2008,” he says.

The study showed that a total of 22.3 percent of companies (102) in the S&P 500 have pay practices that are rated as high concern to investors. A staggering 58.1 percent (265 companies) rated average concern, while 19.5 percent (89 companies) rated as low concern. The study assessed the quality of compensation policies and practices these companies have in place.

Hodgson says the best way for companies to increase their scores is to put in place an effective link between pay and performance, have an uncomplicated approach to compensation policies, and start thinking about executive compensation in exactly the same way they will think about all other employee compensation.

“Companies who treat CEOs as if they are a rare breed of alien who must be coddled out of all proportion to the value they bring to shareholders are likely to have the worst scores,” he says.

The ten metrics used by GMI in their scorecard include:

1. The ratio between the CEO's pay and the median pay of the other named executive officers is 3X or less.

2. The CEO's annual cash incentives rose or fell in line with annual performance.

3. The CEO received no more than one annual cash bonus this fiscal year.

4. The CEO's equity compensation reflected the company's share price movement over the last five years.

5. The company only pays long-term incentives to the CEO for above-median performance against a peer group.

6. Annual and long-term incentives are based on diversified performance metrics.

7. The company's dilution from equity incentives is 10 percent or less.

8. Unvested equity lapses when the CEO's employment is terminated.

9. The CEO's potential cash severance payment is capped at two times the level of annual cash compensation.

10. The accrued benefits for the CEO's post-retirement income are within the typical market range for pension benefits in the S&P 500

GMI said in the next proxy season study, the scorecard will cover companies in the Russell 3000 index.