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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.

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Merit Pay

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  1. 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

  2. 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

  3. 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

  4. 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

  5. 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

  6. 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

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