The WorldatWork Handbook of Compensation, Benefits & Total Rewards: A Comprehensive Guide for HR Professionals

Chapter 14. Linking Pay to Performance

Merit pay, commonly called “pay for performance,” is perhaps the most widely used means by which U.S. organizations determine employee pay increases. The purpose of merit pay is to reward employees for individual contributions and to encourage the best performance possible. In theory, if all employees operate at peak efficiency relative to their capabilities, the organization will thrive.

The logic behind merit pay is straightforward: If pay is made contingent upon performance, then employee motivation to achieve high performance is increased. (See Figure 14.1.) The key to merit pay is founded in three motivational theories:

• Reinforcement theory states that merit pay should motivate improved performance because the monetary consequences of good performance are made known—the better one’s performance, the greater the pay increase will be.

• Expectancy theory states that merit pay should motivate improved performance because performance is instrumental to the attainment of a pay increase—improved effort to perform leads to increased pay.

• Equity theory states that merit pay should lead to improved performance because a pay raise is seen as a fair outcome for one’s performance input—the more one contributes to the organization, the greater the pay increase.

Figure 14.1. Linking pay to performance.

A successful merit pay program will:

• Reward employees for ...