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Pay-for-Performance Plans

A merit pay system links increases in base pay to how highly employees are rated on a performance evaluation. At the end of a performance year, the employee is evaluated, usually by the direct supervisor. The performance rating determines the size of the increase added into base pay. High performance ratings are nearly always statistically related to high merit increases. And removal of merit pay appears to result in lower subsequent performance, as well as lower satisfaction among top performers. Managing merit pay requires an overhaul of the way we allocate raises: improving the accuracy of performance ratings, allocating enough merit money, and making sure the size of the merit increases across performance levels. Merit bonuses are thought to be a substitute for merit pay. Based on employee or company performance, employees receive an end-of-year bonus that does not build into base pay. Because employees must earn this increase every year, it is viewed as less of an entitlement than merit pay. All incentive plans have one common feature: an established standard against which worker performance is compared to determine the magnitude of the incentive pay. For individual incentive systems, this standard is compared against individual worker performance. Because it’s often difficult to find good, objective individual measures, individual incentive plans don’t work for every job. The most frequently implemented incentive system is a straight piecework system. Rate determination is based on units of production per time period, and wages vary directly as a function of production level.