Merit Pay

1
Merit Pay

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

2
Merit Pay (Contd)

• 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.

3
Merit Pay (Contd)

• Employee likely to focus on short-term goals and
  neglect long term goals.
• Employee likely to be judged on outcomes he or
  she 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 Excellent
  Performance may not justify additional effort
  (difference between ave. excellent on scale)

4
Merit Pay (Contd)

• 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.

5
Merit Pay (Contd)

• 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.

6
Merit Pay (Contd)

• 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.