Merit pay
Merit pay is a performance-based compensation system where employee pay is linked to their success in achieving specific performance criteria set by their employer. This approach aims to motivate employees by providing financial incentives tied to their performance, thereby helping organizations identify and retain high achievers and attract new talent. The underlying principle of merit pay is grounded in incentive theory, which suggests that individuals will adjust their behavior in response to rewards.
For a merit pay system to be effective, it must align performance evaluations with the organization’s goals and provide a clear framework for measuring and rewarding performance. Successful systems distinguish between various levels of performance, ensuring that top performers receive significantly higher rewards than their average or below-average counterparts. Additionally, merit pay can be structured as either annual salary increases or one-time lump-sum bonuses, depending on the organization’s budget strategy.
The application of merit pay has been a subject of debate, particularly in education, where linking teacher compensation to student performance raises concerns about fairness and the influence of external factors on student success. While some organizations and government agencies have adopted merit-based pay systems, the effectiveness of such programs in the long term remains a topic of ongoing discussion.
On this Page
Subject Terms
Merit pay
Merit pay is a system of pay for performance. It involves tying pay level to an employee’s degree of success in meeting a specific set of criteria over a given period of time as set forth by the employer. The idea is to provide a financial incentive that will drive employees to deliver desired performance results. At the same time, merit-based pay systems offer employers a means by which to identify, reward, retain, and cultivate high achievers and future leaders within the organization. It also helps employers attract and recruit new performance-driven talent from outside of the enterprise.
Overview
The concept of merit pay is founded on the principles of incentive theory in the field of behavioral psychology. In general, incentive theory reflects the belief that individuals respond to incentives and that those responses can be manipulated, and in the case of performance, elevated, if the appropriate incentive is used.
Over the years, merit pay has become one of the most ubiquitous models for performance-based pay among employers. For a merit pay program to be successful, it must tie performance evaluation directly and consistently with the organization’s mission and goals. Successful merit pay systems also need to incorporate an appropriate framework and tools for measuring and rewarding performance and ensure those resources are available to and understood by the organization’s managers. The best merit pay systems are designed to give each employee a clear and personal incentive for delivering a strong performance in support of the organization’s strategic and operational goals.
At its core, merit pay involves giving employees a pay increase based on their performance over a prior period of work, such as a financial quarter or full year. The amount of the payout typically is based on factors such as the salary range and talent level required for the specific job, the employee’s performance ranking overall and compared with prior evaluations, and the employee’s long-term potential with the organization. Strong merit pay programs strive to ensure that pay rewards given to the organization’s top achievers are substantially greater than pay increases awarded to average or even below-average performers.
Pay-for-performance systems that fail to differentiate pay raise percentages, for example giving the same 3 percent increase to all or most employees regardless of performance level, undermines the merit pay philosophy. In practice, it can also lead to expectations of a pay increase without associated expectations for performance increases. Similarly, organizations that provide merit rewards that fail to account for increases in the cost of living may find that employees consider the pay raise as a necessary entitlement and not a reward for performance. Therefore, to ensure that employees are sufficiently motivated to elevate their performance levels, the amount of the merit reward needs to be large enough to incentivize workers and instigate action.
Some organizations use a one-time lump sum merit-based financial reward versus an annual merit pay increase to an employee’s annual base salary. This type of merit pay incentive uses the same principles and practices of standard pay-for-performance systems but delivers the reward in a single payment rather than dividing the amount over each paycheck. In doing so, the employee receives the earned reward while enabling the employer to hold down overall salary budgets over time.
For many years, the issue of whether teachers should receive merit pay based on student performance has been debated. In 2011, Florida Governor Rick Scott signed a bill into law that was designed to determine the most effective teachers and reward them appropriately. Arguments in favor of the bill also focused on the idea that this pay system would incentivize teachers to further encourage students to perform well in the classroom. Opponents, including the state's teachers union, felt that the law would not allow for fair teacher evaluation, especially for those teachers in fields that do not require as many tests. In 2013, a circuit court dismissed the union's attempt to appeal the law as unconstitutional. The debate over this issue has continued in other states as well. Some experts note that merit-based pay, including one-time bonuses, salary increases, or promotions, fails to motivate teachers long-term. Many factors influencing students' grades are out of the teachers' control, making proper evaluation for merit-based pay difficult. Though no federal merit-based pay plan for teachers became law, the Pay Teachers Act of 2023 increased the minimum pay for teachers across the country, which some posited better-motivated teachers than would a merit-based system.
In the twenty-first century, several organizations and governmental agencies use some form of merit-based pay for certain employees, including Microsoft, ExxonMobil, the Department of Homeland Security, and the Department of Defense.
Bibliography
Baldwin, David A. “Pay for Performance.” The Library Compensation Handbook: A Guide for Administrators, Librarians. Libraries Unlimited, 2003.
Barclay, Lizabeth A., and Kenneth M. York. “Clear Logic and Fuzzy Guidance: A Policy Capturing Study of Merit Raise Decisions.” Public Personnel Management, vol. 32, no. 2, 2003, pp. 287–99, doi.org/10.1177/009102600303200208. Accessed 1 Nov. 2024.
Eskew, D., and R. L. Heneman. “A Survey of Merit Pay Plan Effectiveness: End of the Line for Merit Pay or Hope for Improvement?” Strategic Reward Management: Design, Implementation, and Evaluation. Information Age, 2002, pp. 395–408.
Gratz, Donald G. “Lessons from Denver: The Pay for Performance Pilot.” Phi Delta Kappan, vol. 86, no. 8, 2005, p. 568.
Hathorn, Matthew, et al. “A Mathematical Model of Pay-for-Performance for a Higher Education Institution.” Journal of Economics and Economic Education Research, vol. 12, no. 3, 2011.
Heneman, R. L., and Jon M. Werner. Merit Pay: Linking Pay to Performance in a Changing World. Information Age, 2003.
"Merit Pay." Academy to Innovate HR, www.aihr.com/hr-glossary/merit-pay. Accessed 1 Nov. 2024.
"Merit Pay." U.S. Department of Labor, www.dol.gov/general/topic/wages/meritpay. Accessed 1 Nov. 2024.
Plunkett, Kent, and Heather Bussing. Get Pay Right: How to Achieve Pay Equity That Works. Society for Human Resource Management, 2024.
Postal, Leslie. "In Florida, Teacher Pay Now Tied to Performance." Los Angeles Times, 14 Mar. 2014, www.latimes.com/nation/la-na-teacher-merit-pay-20110326-story.html. Accessed 1 Nov. 2024.
Tang, Rongsheng, et al. Within-Job Wage Inequality: Performance Pay and Job Relatedness. National Bureau of Economic Research, 2020.