At its most basic, merit pay is a form of remuneration intended to motivate employees in an organization to excellence in performance. It is also often referred to as pay-for-performance and works on the principle that “that pay could be a particularly important motivator for employees” (Kim, 2016, p. 150). By invoking such a critical motivator, managers and organizations have a means of increasing “employee performance and productivity,” with some significant research reporting on its “positive effect on performance improvement” (Kim, 2016, p. 150).
Unfortunately, merit pay is not universally effective. In fact, its effectiveness appears to depend on “contextual factors including effective performance appraisals in the organization” (Kim, 2016, p. 151). In other words, problems in the performance appraisal process can significantly impact the efficiency of pay-for-performance programs. Kim (2016) points out that “performance goals and evaluation criteria are often diverse, conflicting, and complex to measure” (p. 151), making it difficult to accurately and fairly assess employees. Furthermore, not everybody is motivated by pay; some individuals are more motivated by intrinsic aspects of their jobs than they are extrinsic elements such as pay and benefits. These problems highlight the difficulties of utilizing a merit pay system. However, they do not mean that a merit pay system cannot work or is inherently unfair. They simply emphasize the importance of developing an effective system which accounts for these problems and taking steps to maintain fairness in that system.

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That employers would utilize rewards to improve or enhance employee performance is a sensible strategy, as long as those employers realize the problems which may arise. And, as noted, they must bear in mind that not all employees will be motivated by pay or other extrinsic and/or material factors. Furthermore, employers cannot and should not rely solely on such systems to motivate employees or to obtain excellence performance from those employees. Employers should also offer training opportunities to enhance their employees’ skill levels and job knowledge; without such training, the potential for unfairness in the pay-for-performance system increases. One might argue that training is a way of leveling the playing field; if all employees have the same training everyone starts on the same footing. It also makes it easier to determine who is making the most of their skills and going above and beyond the minimum requirements.

Pay-for-knowledge is another way of understanding merit pay systems. While some scholars distinguish pay-for-knowledge from pay-for-performance, there is some overlap. Pay-for-knowledge focuses on compensating employees based on their individual educational achievement and skill set, otherwise defined as their competencies. Díaz-Fernández, López-Cabrales, and Valle-Cabrera (2013) define employee competencies as “underlying characteristics of an individual that are causally related to an effective and/or superior criterion-linked performance at a certain job or in a given situation” (p. 643). Competencies can include “knowledge, behaviors and skills” relative to an employee’s job and can be regarded as “resources that enable a company to maintain and improve its competitiveness” (Díaz-Fernández, López-Cabrales, & Valle-Cabrera, 2013, p. 643).

Pay-for-knowledge appears to be less focused on upping the ante, so to speak, and more focused on compensating employees for those competencies. It is not attempting, like a more traditional view of merit pay, to drive employees to higher and higher heights in terms of performance. It is from the outset focused on fairly compensating employees for their education, training, and skills, eliminating the potential unfairness that can emerge from pay-for-performance systems. That said, such a system does not preclude the necessity of training. Much like in the pay-for-performance system, training can help level the playing field. In a pay-for-knowledge system it also helps enhance employees’ competencies, enhancing their value as professionals and as assets to the organization.

  • Díaz-Fernández, M., López-Cabrales, A., & Valle-Cabrera, R. (2013). In search of demanded competencies: Designing superior compensation systems. International Journal of Human Resource Management, 24(3), 643-666. doi:10.1080/09585192.2012.677461
  • Kim, J. (2016). Impact of performance appraisal justice on the effectiveness of pay-for-performance systems after civil service reform. Public Personnel Management, 45(2), 148-170. doi:10.1177/0091026016644625