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Merit Pay. What Is Merit Pay? Pay for Individual Performance Based on Performance Appraisal - Supervisory Judgments of an Employee’s Performance One Year is the Typical Review Period Increase Folded into Base Salary (in most cases) Used in Most US Firms and US Multinationals.

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Merit pay
Merit Pay

What Is Merit Pay?

  • Pay for Individual Performance

  • Based on Performance Appraisal - Supervisory Judgments of an Employee’s Performance

  • One Year is the Typical Review Period

  • Increase Folded into Base Salary (in most cases)

  • Used in Most US Firms and US Multinationals

Managing Employee Reward Systems


Merit pay cont d
Merit Pay (Cont’d)

Many Problems with Merit Pay

  • Performance Appraisal is Subjective and is Subject to Errors & Biases:

    • Leniency, Stringency, Central Tendency Bias

    • Halo, Recency, Contrast Effect Errors

  • Difficulty Measuring Employees’ Work Outcomes in Many Jobs - What gets measured is behavior or traits in some cases.

  • May place too much Emphasis on Individual Goals and lead to goal conflict with others in unit/group.

Managing Employee Reward Systems


Merit pay cont d1
Merit Pay (Cont’d)

  • Employee likely to focus on short-term goals and neglect long term goals.

  • Employee likely to be judged on outcomes he orshe cannot control such as system factors.

    • Ex. Sales Rep receives a poor sales territory compared to other sales reps. Sales are more difficult in this one.

  • Timing is poor - only given on annual basis.

  • Size of Marginal Increase for ExcellentPerformance may not justify additional effort (difference between ave. & excellent on scale)

Managing Employee Reward Systems


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Merit Pay (Cont’d)

  • Non-Performance Factors (Seniority and Cost of living) may Dilute Merit, reducing the Credibility of the Pay for Performance Relationship.

  • Limited Budgets for Merit Pay - May result in zero sum game, in which some “good” performers are labeled “average” or “poor” in a ranking or forced distribution scheme to ration pay raises.

  • Merit pay increases may be viewed as an entitlement - or an annuity earned only once, but received in salary in perpetuity.

Managing Employee Reward Systems


Merit pay cont d3
Merit Pay (Cont’d)

Best Practices for Merit Pay

  • Use Valid Performance Appraisal System

    • Accepted by Employees/Free of Politics

    • Valid Measures of Individual Performance

  • Have a Large Enough Merit Pay Budget (at least 5 percent of payroll) to Recognize Different Performance Levels with Pay Meaningfully.

  • Works Best in Private Sector firms where high performance is an important cultural value.

Managing Employee Reward Systems


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Merit Pay (Cont’d)

  • Consider Alternatives to Merit Pay if conditions are not favorable for it.

    • Individual Lump Sum Bonuses

    • Skill-based Pay

    • Team Bonuses

    • Annual Market Adjustments (Seniority increases)

  • Employees should be Able to Challenge their Merit Increase

    • Appeal Mechanism such as Open Door Policy which lets another manager or committee review the pay decision and make an independent judgement.

Managing Employee Reward Systems