Merit Pay, Performance Appraisal, and Individual Motivation • 131

MERIT PAY, PERFORMANCE APPRAISAL,

AND INDIVIDUAL MOTIVATION:
AN ANALYSIS AND ALTERNATIVE

Donald J. Campbell, Kathleen M. Campbell,

and Ho-Beng Chia

Theories of motivation and common expectation argue that people who contribute more to an
undertaking should receive more from it. This expectation has significantly influenced the de-
sign of compensation systems. Merit pay reflects this influence. Nonetheless, in spite of intuitive
appeal and apparent theoretical support, merit pay rarely achieves its objectives. This article
reviews five common implementation issues. It also argues that merit plans underemphasize
important attribution biases that affect performance judgments. These biases suggest that such
plans would still have limited effectiveness, even if implementation problems were overcome.
The article presents an alternative focused on group accomplishment. © 1998 John Wiley &
Sons, Inc.

Introduction most individuals regarding pay (e.g., Hills,

In a globally competitive environment, where
human resources must be effectively engaged,
the appeal of merit pay compensation is obvi-
ous. Merit pay plans relate adjustments in an
employee’s base pay directly to that person’s
job performance (Henderson, 1989). These
plans theoretically forge a link between pay
expenditures and individual productivity; and
even when such linkages may not actually ex-
ist, the plans still communicate a useful mes-
sage to employees (Gomez-Mejia & Balkin,
1992).
Additionally, merit pay schemes contain
another benefit. Such schemes reflect the
“norm of distributive justice.” This is the com-
monly held belief that individuals should be
rewarded in proportion to their contributions.
This norm apparently captures the feelings of
Scott, Markham, & Vest, 1987). Thus, by con-
forming to this expectation, merit pay ap-
proaches potentially diffuse concerns about
equity and fairness.
Finally, theories of human motivation also
support the use of merit pay. These theories
encourage managers to tie important out- From several
comes to desired behaviors. Thus, whether perspectives,
managers endorse some variant of expectancy merit pay
theory (Porter & Lawler, 1968; Vroom, 1964) schemes do seem
or reinforcement theory (Skinner, 1974), the desirable; yet,
in spite of this,
message is clear: To sustain motivation, man- merit pay often
agers must demonstrate to employees a close brings about
link between performance and rewards. results precisely
From several perspectives, merit pay the opposite
schemes do seem desirable; yet, in spite of this, from those
desired.
merit pay often brings about results precisely
the opposite from those desired: dissatisfac-
tion, discouragement, and decreased perfor-

Human Resource Management, Summer 1998, Vol. 37, No. 2, Pp. 131–146
© 1998 John Wiley & Sons, Inc. CCC 0090-4848/98/02131-16
132 • H UMAN RESOURCE MANAGEMENT, Summer 1998
mance (Gomez-Mejia & Balkin, 1992,
Hughes, 1986; Kanter, 1987; Whyte, 1955).
Although the potential problems with
merit pay have been widely discussed (e.g.,
Dessler, 1994; Fisher, Schoenfeldt, & Shaw,
1993; Henderson, 1989), these difficulties
have not lessened its attractiveness. Firms
seem to prefer a merit pay approach to other
alternatives, and HR professionals have re-
sponded by identifying the conditions “favor-
able” to merit pay. These efforts imply that, in
the right circumstances, merit pay can lead to
overall increases in motivation and perfor-
mance. We believe that, even in favorable cir-
cumstances, merit pay is unlikely to bring
about these outcomes. Consequently, firms
may want to explore alternatives to merit pay.
The purpose of this article is threefold.
First, we examine the problems associated with
merit pay and evaluate proposed solutions.
Second, we consider important attribution
errors that attenuate merit pay effectiveness,
arguing that these problems have been
underemphasized. Finally, we propose a work-
unit based alternative to individually-oriented
merit pay systems.
Problems Associated with Merit Pay
Several kinds of problems hamper the effec-
tiveness of merit pay. Most reflect some type
of implementation hurdle. Others entail po-
tential problems should the firm actually
implement a merit pay approach. We have clas-
sified the various difficulties into five catego-
ries: (1) measurement issues, (2) performance
appraisal (PA) feedback and acceptance issues,
(3) reward desirability issues, (4) system
“noise” issues, and (5) unintended conse-
quences. Of course, a specific merit pay prob-
lem may have roots in several categories.
Measurement Issues
Merit pay measurement issues take two forms.
First, can the firm actually measure individual
performance? Second, can the firm clearly
distinguish between individuals whose jobs are
interrelated? For the first question, the answer
is surprisingly equivocal. While firms have
many methods for gauging performance, the
validity and accuracy of the most commonly
used method, supervisory ratings (Milkovich
& Boudreau, 1991), has always been a major
concern. These measures are likely to suffer
from both deficiency and contamination prob-
lems, including subjectivity, personal bias,
deliberate distortion, and various other inten-
tional and unintentional rating errors (e.g.,
halo, contrast, central tendency, etc.). All these
problems call into question the accuracy of
the performance measure (Balkin & Gomez-
Mejia, 1987; Latham & Wexley, 1981;
Longenecker, Sims, & Gioia, 1987).
The second problem is the issue of “inter-
related performances” where the work tasks
of two or more individuals are tied together.
Here, the firm typically has great difficulty in
separating the unique contributions of the
various individuals. Even when such determi-
nations appear possible, some investigators
(Deming, 1986) have questioned whether
separation is justified, since individuals were
not entirely in control of their own results.
Traditional Solution. To overcome the first
difficulty, human resource (HR) researchers
have suggested a dual strategy. First, they have
recommended that firms move away from
highly subjective judgments to more specific
and objective measurements. Second, they
have suggested that firms train appraisers to
avoid the common errors that occur in per-
formance measurement.
The current shift from measuring individual
traits (e.g., initiative), to measuring job behav-
iors and job results (Fisher et al., 1993) reflects
the first aspect of this dual strategy. The inher-
ent objectivity of measuring performance against
either output or goals is evident. Where output
measures are less appropriate, an array of be-
havioral measures is available. These measures
include behaviorally anchored rating scales
(BARS); behavioral observation scales (BOS);
and behavioral discrimination scales (BDS).
These measurement approaches have specifi-
cally evolved to overcome the difficulties asso-
ciated with the graphic rating scale (Carroll &
Schneier, 1982).
Researchers have also championed rater
training as highly effective in reducing mea-
surement rating errors. Simply by training
raters in how to avoid common errors, firms
can make the measurement process more

accurate and objective (Latham & Wexley,
1981); thus, training and a results- or behav-
iorally-oriented appraisal focus may minimize
measurement problems.
For interrelated performance, research has
not provided any solution. The literature (e.g.,
Gomez-Mejia & Balkin, 1992) simply suggests
that merit pay is a less feasible option under
these circumstances. Merit pay is limited to
situations in which managers can make fairly
clear performance attributions and employees
generally perform independent work.
PA Feedback and Acceptance Issues
For merit pay plans to work, employees must
agree that pay distinctions based on the perfor-
mance measures are fair. In other words, it is
not sufficient for the measures simply to be ac-
curate; employees must perceive them as accu-
rate. For many firms, the problems discussed
have sensitized employees to regard PA with
suspicion and cynicism—creating two concerns.
Employee Acceptance. Employees generally
do not agree with their performance appraisals
(Campbell & Lee, 1988; Meyer, 1980) and pre-
sumably do not accept the evaluations as accu-
rate. Although the use of observable, objective
criteria lessens this problem, it does not elimi-
nate it. As Fisher et al. (1993) have noted, fac-
tors beyond the individual’s control (e.g., the
quality of a work machine) can affect even ob-
jective performance. This makes it less likely
that an individual will accept a disappointing
evaluation even when no disagreement exists
about the outcomes. The numbers are not in
dispute; the causes for the numbers are.
Additionally, a complex set of informa-
tional, cognitive, and affective constraints in-
fluences self evaluation, and these constraints
make it extremely unlikely that individuals will
agree with evaluations lower than their own
(Campbell & Lee, 1988). While deliberate
distortion may account for some of the dis-
agreement, more fundamental factors (i.e.,
different cognitive schemas; defense mecha-
nisms, etc.) appear to be operating. Because
of such disagreement, many employees sim-
ply do not see merit pay as truly rewarding
performance (Hills et al., 1987; Kanter, 1987;
Vest, Hills, & Scott, 1989).
Merit Pay, Performance Appraisal, and Individual Motivation • 133
Supervisory Feedback Skills. Giving evalu-
ative feedback is often anxiety-provoking for
the appraiser, and managers are often uncom-
fortable with the whole feedback process. Sev-
eral factors contribute to this. First, the typical
feedback session is characterized by disagree-
ment, making the usual session unpleasant.
Second, the supervisor is trying to accomplish
several distinct objectives by providing feed-
back: that is, evaluating and rewarding past Finally, a
performance while attempting to develop and considerable
motivate future performance. This dual focus amount of skill
makes it difficult to accomplish either of the is needed to
conduct an
objectives well. effective
Finally, a considerable amount of skill is appraisal
needed to conduct an effective appraisal in- interview, and
terview, and many managers apparently do not many managers
possess the requisite skill. It is, therefore, not apparently do
not possess the
surprising that many managers see little value requisite skill.
in PA interviews (Napier & Latham, 1986), or
that many employees feel that appraisal feed-
back causes more confusion than enlighten-
ment (Meyer, 1991).
Traditional Solution. To increase employee
acceptance of PAs (and thus the merit deci-
sions based on them), researchers have rec-
ommended that appraisers involve employees
in the evaluation process. Evidence
(DeGregorio & Fisher, 1988) suggests that
individuals desire such involvement and that
participation may increase acceptance of the
appraisal results.
Investigators have also suggested strate-
gies for reducing the problems supervisors face
when giving feedback. Textbooks often pro-
vide guidelines for appraisers to follow (e.g.,
“prepare carefully, provide specific examples,”
and so forth). These can reduce anxiety by
structuring an ambiguous task. They may also
help develop the skills needed to conduct bet-
ter appraisals.
For the problem of multiple objectives, it
has long been recommended that separate
interviews be used for evaluation and devel-
opment purposes (Meyer, 1991; Meyer, Kay,
& French, 1965). By separating the interviews,
supervisors can focus on past performance and
merit pay in one session, and cover develop-
mental issues and future goals later, when
defensiveness is lower.
Are these recommendations effective?
Certainly participation and involvement are
134 • H UMAN RESOURCE MANAGEMENT, Summer 1998
helpful, and more skillfully conducted inter-
views are useful. Nonetheless, at least as early
as 1965, Meyer and his colleagues dealt with
the same issues and pointed out the same so-
lutions. A quarter-century later, he has re-
ported that little has changed (Meyer, 1991).
One survey of American firms, cited by Meyer
(1991), indicated that less than 10% have suc-
cessful PA programs; another nationwide sur-
vey (Meyer, 1991) indicated that the PA system
is the firm’s most frequently mentioned HR
concern. Nor are these results limited to just
American firms. In a survey of 74 companies
across all sectors of the Singaporean economy,
a major consultancy firm found that fewer
than 30% of employees believed that perfor-
mance appraisal helped them (Straits Times,
1995). Such widespread and consistently dis-
couraging results question the efficacy of the
recommendations themselves.
Reward Desirability Issues
A workable merit pay system requires the firm
to budget sufficient funds for meaningful pay
differentials. Managers must attach suitably
large pay differences to suitably large perfor-
mance differences (Wallace & Fay, 1988).
Debate exists whether this typically occurs.
Lawler (1981) has suggested that at least a
3% pay change is needed for individuals to
notice a difference. He later concluded that
the typical pay differential between poor and
outstanding performance is too small (cited
in Henderson, 1989).
Henderson (1989), however, has sug-
gested the typical merit pay differential be-
tween high and low performers is 4%. Over
ten years, this leads to a sizable difference in
overall earnings. Whether employees adopt a
ten-year perspective when evaluating a merit
increase is not known.
Traditional Solution. Some investigators
have proposed paying top performers increases
that are four times the increases paid to poor
performers (Fisher et al., 1993). With such a
differential, employees would certainly see a
difference; however, while large merit differ-
entials can eliminate the reward desirability
issue, practical constraints usually operate to
restrain merit differentials. A firm needs to
budget enough money to make merit pay
“work,” but clearly it would prefer to spend
no more than this. A firm might object to an
arbitrarily large merit differential determined
primarily by fiat. Alternatively, cost-benefit
analyses of merit pay levels might empirically
determine the appropriate differential. Such
analyses, however, are usually too impractical
to generate.
Instead, many firms simply determine
what they are willing to spend on merit in a
given year. To ensure that a reasonable merit
differential exists, these firms then treat merit
as a zero-sum distribution (e.g., Thompson &
Dalton, 1970), with a higher-than-average pay
increase to one employee requiring a lower-
than-average pay increase to another. This
approach allows managers to create relatively
large merit differentials even with small merit
budgets. It does so, however, by implicitly
evaluating an individual’s job performance
against work group peers, rather than against
absolute achievement. This approach presum-
ably is not what individuals anticipate when
calling for merit pay.
System “Noise” Issues
Factors only indirectly relevant to merit pay
can obscure the firm’s efforts to link pay to
performance. Such factors represent “back-
ground noise” drowning out the merit pay “sig-
nal.” Two factors are particularly troublesome.
Timing of Merit Pay. Firms typically pro-
vide merit adjustments on an annual basis.
Thus, most employees experience a significant
time lapse between job performances that
warrant merit and the actual reception of merit
pay. Motivational theorists (e.g., Skinner,
1974) have pointed out that such delays sub-
stantially dilute the efficacy of the reward and
also hide the performance-reward connection
from the individual.
Reward System Inconsistencies. The firm’s
pay system does not represent its only reward
system. Managers typically have available a
large number of other rewards that they can
bestow or withhold (Fisher et al., 1993). If
supervisors use these non-monetary rewards
carelessly, employees receive mixed signals.

Unless such rewards are also performance-
based, they can weaken perceived merit
connections.
Similarly, performance is rarely the only
factor that determines merit pay. These other
factors (e.g., an individual’s position in the
salary range, the existence of pay compression,
pay relationships within the work group, “start-
ing point” differentials) can also hide the per-
formance-pay link (Balkin & Gomez-Mejia,
1987; Gomez-Mejia & Balkin, 1992).
Traditional Solution. The noise problems
described above represent inherent character-
istics of organized life. While closer temporal
connections between performance and pay may
be extremely attractive, the administrative diffi-
culties in bringing these about make significant
change unlikely. Similarly, organizational com-
plexity makes it unlikely that a firm’s numerous
reward systems can always be consistent. Of
course, an awareness of these problems may help
minimize counterproductive results.
Additionally, in PA feedback sessions,
firms can go to great lengths to demonstrate
and clarify performance-reward connections.
In this regard, noise problems highlight the
importance of individual trust in the perfor-
mance appraisal system. Without such trust,
a supervisor will be unlikely to convince indi-
viduals that contradictions in the merit sys-
tem are just random fluctuations.
Unintended Consequences
Another set of problems may arise after a firm
adopts a merit pay approach. Such problems
represent potential costs that can negate the
benefits of merit pay. The problems are
grouped into two categories.
Task-Focus Consequences. Merit pay can
make individuals “single-minded” and inflex-
ible about performance (Gomez-Mejia &
Balkin, 1992). Employees may only engage in
those activities directly related to reward at-
tainment and neglect other important but less
tangible aspects of the job (e.g., properly so-
cializing newcomers to the firm). This poten-
tial problem is exacerbated in complex
managerial and professional jobs because no
measurement system can truly capture all the
Merit Pay, Performance Appraisal, and Individual Motivation • 135
potentially important aspects of such work. A
merit pay approach may thus cause managers
to concentrate on short-term achievements
(i.e., those “blossoming” in the merit pay pe-
riod) and even to resist attempts to change
reward-linked, but outdated, activities.
Affective Consequences. Some investigators
(e.g., Schwab, 1974) have raised the possibility
of a performance-satisfaction tradeoff with merit
pay. Incentive systems may increase an
individual’s performance but also introduce ex-
tra tension and stress, thus reducing satisfac-
tion. Others (Gomez-Mejia & Balkin, 1992)
have speculated that individuals may perceive
merit pay as threatening their personal au-
tonomy and reducing their freedom of action.
As a result, they experience anger and dissatis-
faction. In a related vein, merit pay also may
reduce an employee’s “intrinsic motivation,” that
is, the individual’s intrinsic desire to perform
an otherwise interesting and engaging activity
(Deci & Ryan, 1985). This long-run loss of in-
trinsic interest may more than offset merit pay’s
short-run motivational gains.
Traditional Solution. Since the above are
primarily potential problems, researchers have
not examined them in any depth. This is par-
ticularly true for affective consequences. For
example, some investigators simply question
the applicability of Deci’s work to the typical
work organization (e.g., Staw, 1977). Thus, the
absence of solutions to questionable problems
is understandable.
The unintended consequences of single-
mindedness, inflexibility, and so forth are less
easily dismissed. Researchers have frequently
asserted that firms “get what they measure.”
By implication, firms do not get what they do
not measure. Although a firm should measure
Researchers
all truly important activities, in practice, this have frequently
expectation is unrealistic. Given the rapidly asserted that
shifting, temporally-specific requirements of firms “get what
the modern firm, comprehensive measure- they measure.”
ment is an ideal toward which the organiza-
tion strives, not a goal which it achieves.
Consequently, some investigators have
argued that a tight connection between per-
formance and reward is rarely justified
(Gomez-Mejia & Balkin, 1992). They have
suggested that it is better if the pay-perfor-
mance link is only “loosely coupled.” Then,
136 • H UMAN RESOURCE MANAGEMENT, Summer 1998

by customizing various performance-contin- The Problem of Attribution

gent pay programs to its particular circum-
stance, the firm may reduce the likelihood of
unintended results. No empirical evidence
documents the effectiveness of such
customization, however, and it is not clear how
customization reduces single-mindedness in
firms using just a merit pay approach.
Table I summarizes the problems and pro-
posed remedies associated with merit pay.
As Table I indicates, researchers have sug-
gested solutions for the problems with merit
pay. Still, surveys show the same dissatisfac-
tions with evaluation and reward occurring
today as 30 years ago (Meyer, 1991). This ar-
gues that limitations associated with merit pay
go beyond these difficulties.

TABLE I Summary of Problems Associated with Merit Pay.

1. Poor Measurement of Performance Traditional Solutions

a) Low validity of supervisory ratings. Use more objective measures/scales.
Train raters to avoid common errors.
b) Work dependencies among individuals. Avoid merit pay in these cases.
Remaining Issues: Merit pay seems limited to only some situations.

2. Poor Acceptance of Supervisory Feedback Traditional Solutions

c) Disagreement with evaluation. Involve employees in the process.
d) Supervisors unskilled in giving feedback. Train supervisors with guidelines.
e) Conflicting feedback objectives. Use a separate session for each objective.
Remaining Issues: Dissatisfaction with PA still consistently reported.

3. Limited Desirability of Merit Reward Traditional Solutions

f) Typical merit increase too small. Increase merit percentages.
Use zero-sum distributions.
Remaining Issues: Difficult to determine adequate percentage.
Reluctance to increase expenditures.
Unfairness of rewarding relative performance.

4. Noise Hides Work-Merit Link Traditional Solutions

g) Too great a time lapse time. Clarify work-merit link in PA sessions.
h) Inconsistencies among reward systems. Build trust in the PA system.
i) Factors other than performance affect merit. Use vigilance and sensitivity to reduce.
Remaining Issues: Effective implementation of the solutions quite difficult.

5. Potential Unintended Consequences Traditional Solutions

j) Focus is only on merit-related activities. Use a loosely coupled approach to merit.
k) Loss of satisfaction and intrinsic motivation. No consensus that these are real issues.
Remaining Issues: No hard evidence supports a loosely coupled approach.

Differential Performance Attributions
One explanation for these discouraging find-
ings is that of differential attribution. Attribu-
tion theorists (e.g., Jones & Nisbett, 1972)
have traditionally examined how individuals
infer the “causes” underlying another person’s
behavior and how these inferences affect re-
lated judgments. For example, individuals
evaluate the same level of performance dif-
ferently depending on whether they attribute
the cause of performance to the person’s ef-
fort or to his ability. If a supervisor infers that
high (or low) performance is due to effort, he
typically rates that performance higher (or
lower) than if he infers the same performance
is due to ability (e.g., Knowlton & Mitchell,
1980).
Attribution theorists have also docu-
mented that an actor (e.g., an employee) and
an observer (e.g., an evaluator) do not make
identical causal attributions in “accounting
for” the employee’s actions and outcomes. Two
related attribution “effects” are particularly
relevant to this discussion.
Actor-Observer Effects. Actors and observ-
ers rarely attribute the causes of behavior simi-
larly (Brown, 1984; Heider, 1958; Watson,
1982). Although exceptions occur (cf., Porac,
Ferris, & Fedor, 1983), actors typically are
highly conscious of environmental constraints
and see these constraints as significant deter-
minants of their actions. Observers are less
knowledgeable about and less sensitive to situ-
ational demands. They tend to see personal
characteristics as the cause of the actor’s be-
havior. For example, Brown and Mitchell
(1986) described a scenario involving low
employee performance to 46 supervisors. They
then had these individuals rate the likelihood
that each of eight potential factors contrib-
uted to the performance problem. Respon-
dents saw employee-centered factors (e.g.,
motivation and ability) as significantly more
likely than work-system factors. This propen-
sity to gravitate toward personal attributions
in accounting for low employee performance
confirmed an observation of earlier research-
ers (i.e., Mitchell, Green, & Wood, 1981).
A manager and an employee are, there-
fore, likely to disagree about the merit wor-
thiness of a low performance outcome even if
Merit Pay, Performance Appraisal, and Individual Motivation • 137
they agree about the performance outcome
itself. As noted earlier, an employee may ac-
knowledge his/her failure to reach a perfor-
mance sales target, but then attribute the
failure to unexpectedly poor economic condi-
tions beyond his/her control. In contrast, while
interpersonal factors can sometimes mitigate
supervisory inferences (cf., Heneman,
Greenberger, & Anonyuo, 1989), the super-
visor’s normal tendency is to attribute the fail-
ure to some shortcoming of the individual
(e.g., lack of effort). If the supervisor is par-
ticularly dependent on the subordinate, this
tendency is significantly increased (e.g., Ilgen,
Mitchell, & Fredrickson, 1981).
Self-Serving Bias. Additionally, individu-
als usually attribute positive outcomes to their
own effort and ability and attribute negative
outcomes to circumstances and the actions
of others (Bierhoff, 1989; Fiske & Taylor,
1984). With favorable outcomes, individuals
infer that their skill and determination over-
came significant situational barriers. With
unfavorable outcomes, they infer that even
skill and determination were not sufficient.
Thus, individuals typically will feel more re-
sponsible for achievements than for failures,
and they may be genuinely surprised if their
manager indicates otherwise.
Such attributions apparently allow indi-
viduals to interpret potentially threatening
work experiences in ways that maintain self-
esteem (Gioia, 1989). For example, Johns
(1994) has demonstrated self-serving bias with
a sample of employees and managers estimat-
ing their own level of absenteeism (i.e., a form
of job performance). These respondents con-
sistently underestimated their own absentee-
ism, and reported their colleagues as missing
more days than they themselves. Although self-
serving, such attributions take various forms
(e.g., Sanna & Mark, 1995) and are universal
(cf., Mullen & Riordan, 1988).
Relevance to Merit Pay
Performance appraisal specialists have been
aware of these attribution effects (e.g.,
Bernardin & Beatty, 1984; Carroll & Schneier,
1982), but they have typically treated the ef-
fects as just another type of rating bias which
138 • H UMAN RESOURCE MANAGEMENT, Summer 1998
training and better measurement might over-
come. Such an expectation overlooks the full
significance of the problem. Because differ-
The ences in attributions are inherently rooted in
attractiveness the positions of actor and observer, they are
of merit pay lies not likely to disappear even with better mea-
(1) in its sures and improved feedback.
potential to Such improvements only help individuals
stimulate high
performance agree on the facts of performance. Agreement
and (2) in its about the facts is necessary but not sufficient
transparent for a successful merit program. The causal
equity. interpretations that individuals see beneath
the facts are of primary importance. At this
level, attribution theory implies that supervi-
sors and employees will almost always reach
conflicting conclusions (cf., Campbell & Lee,
1988).
Self-serving bias and actor-observer effects
may explain the well documented tendency of
employees to overrate their job performance
and therefore to conclude that the merit pay
system is working improperly. If the theory is
correct, these subjective conclusions are in-
evitable even with an objectively flawless per-
formance appraisal and merit pay system in
place.
In practical terms, self-serving bias and
actor-observer effects suggest that firms can-
not realistically anticipate more than modest
success with traditional merit pay plans. Al-
though merit pay is certainly an important
symbol of a collectively held, deep-seated value
(i.e., rewards in proportion to contribution),
the problems above vitiate the concept’s prom-
ise. Further, research specifically focused on
the effectiveness of merit pay confirms this
conclusion. While this research generally in-
dicates that merit pay and employee attitudes
are positively related, it also shows that little
or no relationship exists between merit pay and
subsequent performance and motivation
(Heneman, 1992).
The analysis presented in this article an-
ticipates these empirical findings. The con-
cept of merit pay generates positive job and
pay attitudes because the idea itself conforms
to the norm of distributive justice. In actual
operation, however, individuals experience the
various implementation and attributional dif-
ficulties discussed and presumably become
disheartened with their specific plan (but not
necessarily with the concept itself).
A Work-Unit Based Alternative
The attractiveness of merit pay lies (1) in its
potential to stimulate high performance and
(2) in its transparent equity. Any proposed al-
ternative should, therefore, have these two
characteristics and also minimize the difficul-
ties associated with merit pay. The following
sections of the article describe and evaluate
an alternative based on group performance.
Performance Indicators (PIs) and
Work Group Evaluation
Although HR researchers have not emphasized
group-level PA, related disciplines have de-
scribed measurement approaches that make
group evaluation feasible and attractive. The
control and evaluation literature (Brinkerhoff
& Dressler, 1990), the industrial engineering
literature (Ross, 1993), and the financial ac-
counting literature (Anderson & Camealy,
1991; Edmunds, 1982) have all considered
unit-level performance.
These areas suggest that a work unit’s per-
formance can be tracked through the use of
performance ratios (i.e., measures of a work
unit’s key outputs in relation to critical inputs).
Outputs consist of whatever services or prod-
ucts the work unit produces and typically are
measured in terms of clients served, units pro-
duced, and other appropriate elements. Inputs
consist of whatever the unit consumes in cre-
ating its services and products and typically
are categorized into components such as la-
bor, material, capital, and energy.
Called “management indicators” (Shimizu,
Wainai, & Nagai, 1991), “productivity indices”
(Brinkerhoff & Dressler, 1990), “productivity
ratios” (Sink, 1985), and “performance indica-
tors” (Jowett & Rothwell, 1988), these measures
all link unit objectives and targets to actual
achievement in a clear, direct way. Since a num-
ber of researchers (Sink & Tuttle, 1989) have
described extensive procedures for developing
PI evaluation systems, we give only a quick over-
view of one approach (cf., Campbell, Campbell,
& Chia, 1995).
Creating PIs: Preliminary Steps. First, the
work group undertakes an analysis of the unit’s

mission, goals, and objectives. This is analo-
gous to conducting a thorough job analysis but
at the work unit level. Typically, the group uses
a structured communication/decision making
technique, allowing members to consensually
identify the unit’s fundamental mission.
The group captures its mission in a writ-
ten statement and uses it to identify the work
unit’s goals and “customers.” Members then
analyze the work unit from its clients’ perspec-
tives. For each of the unit’s customers, the
group identifies the unit’s products and ser-
vices most valued by that customer. These rep-
resent the unit’s key outputs, those products
and services most responsive to meeting cus-
tomer expectations. Measures of these prod-
ucts must form part of the unit’s PI system.
The group also reviews the functional pro-
cesses of the unit, that is, the unit operations
that transform inputs into outputs. This ex-
amination exposes the procedures important
for the transformation process and the key
inputs vital for creating the unit’s products and
services. By the end of these steps, the group
has systematically reviewed the purposes,
products, and processes of the unit and has
developed a shared understanding of areas and
activities critical for unit performance. At its
best, this analysis stimulates members to con-
sider not only what the unit actually does, but
also what it should be doing.
The Ratios
The actual PIs are ratios of outputs to inputs.
The unit initially creates an exhaustive list of
output measures and then selects the most
promising of these potential measures. Selec-
tion is based on (1) the measure’s importance
and centrality, (2) the cost and effort required
to obtain the measure, (3) the measure’s “cycle”
time (i.e., the time needed for a change to reg-
ister on the measure), (4) its sensitivity to small
changes, and (5) its relative subjectivity.
Similarly, the unit carefully generates,
evaluates, and selects input measures. Focus
is on those inputs associated with the produc-
tion of outputs selected for tracking. Common
input measures include hours worked, unit
payroll expenditure, raw material used, energy
consumed, and so forth.
Merit Pay, Performance Appraisal, and Individual Motivation • 139
Since even a small work unit has numer-
ous products and customers, a single overall
PI is usually inadequate. On the other hand,
an attempt to track all potentially relevant PIs
may result in information overload. Some re-
searchers have suggested that groups develop
a “family” of PIs (a group of separate but mean-
ingfully related measures) for the 20% of unit
products and services that account for 80% of
the success of the unit. Others (Globerson,
Globerson, & Frampton, 1991) have recom-
mended a maximum of seven central PIs.
Several investigators provide examples of
PIs relevant to particular work groups, and
Table II illustrates some of these PIs.
Benefits of a Unit-Level PI Approach
This section examines the potential advantages
of a PI approach.
Measurement Benefits
The use of performance indicators addresses the
two broad measurement problems confronting
traditional individual appraisal: subjectivity and
interdependency. As noted, PIs are expressed
as some type of statistical ratio. This heavy em-
phasis on objectivity and quantification mirrors
the recommendations of HR specialists and
embodies trends already evident in traditional
performance evaluation. By moving away from
subjective judgments and substituting objective
ratios, many of the errors associated with rating
measures (e.g., leniency, halo, and so forth) are
no longer relevant. Even deliberate distortion is
less likely because of the statistical nature of
the PIs.
Further, because the firm evaluates at the
group level, judgmental problems associated
with individual interdependencies are also ir-
relevant. Since unit performance ultimately
determines each member’s merit pay, the firm
avoids having to sort out degrees of perfor-
mance at the individual level.
Of course, the use of PIs assumes that
the firm has carefully determined the unit’s
important performance dimensions, avoiding
both deficiency errors (i.e., the omission of
an important element that should have been
140 • H UMAN RESOURCE MANAGEMENT, Summer 1998

TABLE II Illustrative Performance Indicators Developed for Various Work Units.*

Human Resource Management Department

1. Number of Individuals Trained/Training Costs
2. Number of Change Notice Errors/Total Number of Change Notices
3. Number of Insurance Claims Processed/Number of Claims Clerks
4. Grievances Settled Satisfactorily/Total Number of Grievances

Finance Department
1. Invoices Processed/Invoicing Hours
2. Invoicing Errors/Invoices Processed
3. Number of Pricing Proposals/Number of Pricing People
4. Incomplete Cost Standard/Total Cost Standards

Production Department
1. Wait Time Hours/Direct Labor Hours
2. Customer Accepted Lots/Lots Submitted
3. Warranty Repair Costs/Sales
4. Hours on Labor Ticket Rejects/Total Hours Reported

Marketing Department
1. Change in Sales/Change in Marketing Expenditures
2. Product Awareness Level/Product Marketing Budget
3. Market Share/Promotional Expenditures

* Adapted from Globerson et al., 1991; and from Sink, 1985.

included) and contamination errors (i.e., the
inclusion of an irrelevant element). Addition-
ally, reliability and validity are as fundamental
for good PIs as these characteristics are for tra-
Performance ditional individual measures. Finally, similar to
Indicators have
a number of individual appraisal, useful PIs are sensitive to
advantages in small changes in performance; they are under-
terms of feedback stood; and they are responsive to the actions of
and acceptance. unit members (Campbell et al., 1995). Although
PIs provide measurement benefits that go be-
yond individual measures, they have much in
common with such measures.
Acceptance and Feedback Benefits
PIs have a number of advantages in terms of
feedback and acceptance. First, because eval-
uation is at the work unit level, individual
defensiveness is greatly reduced. Since mem-
bers are jointly responsible for performance,
no individual is singled out for weak achieve-
ment. Poor unit performance becomes a prob-
lem requiring a solution rather than a threat
to be deflected. Second, PIs provide feedback
without the interpersonal evaluation compo-
nent present in traditional appraisal. The work
design literature suggests that direct, unfil-
tered information from the task itself is supe-
rior to supervisory feedback. PIs supply this
type of feedback. Additionally, the quality of
the feedback is independent of supervisory
communication and interpersonal skills.
Because the group itself helped create the
PIs, members are likely to accept results based
on such measures as meaningful and relevant.
Additionally, with PIs, work units typically
receive feedback more frequently than is

feasible with individual appraisal. This gives
the firm more opportunity to acknowledge
good results (Campbell et al., 1995).
Reward Benefits
While PIs cannot create more (or more desir-
able) rewards, their use may help the firm
avoid problems associated with reward desir-
ability. Specifically, a PI system allows the firm
to closely examine the relationship between
budgets and performances for various units.
Relative to individual evaluation, such inspec-
tions can be more thoughtful and are more
likely to reveal inappropriate levels of merit
allocations. Also, with group level PIs, the
problem of rewarding one high performer at
the expense of another is pushed to the unit
level, where the firm has a better chance of
detecting and correcting it.
Noise Reduction
Noise in an appraisal system is usually linked
to reward timing and to conflicts among re-
ward systems. Such problems are particularly
likely with traditional appraisal because of the
sheer number of individuals involved. With
unit-level PIs, the firm monitors far fewer units
and has a better chance of minimizing these
difficulties. Also, with PIs, firms can informally
reward superior performance whenever unit
performance truly warrants such recognition.
By making timely reinforcement feasible, the
PI system can keep the performance-reward
link salient in the minds of employees, even if
the formal merit adjustments only occur on
an annual basis.
The use of PIs can also dampen the likeli-
hood of serious reward inconsistencies. Be-
cause the firm links the primary reward system
to group level accomplishment, reward system
conflicts occurring at the individual level are
usually less conspicuous and damaging.
Reduction of Unintended Consequences
Individual merit pay can encourage employ-
ees to focus only on tasks that are rewarded.
In contrast, PIs encourage employees to adopt
Merit Pay, Performance Appraisal, and Individual Motivation • 141
a broad perspective and to think of achieve-
ment in terms of the unit’s mission. With PIs,
each individual’s responsibility encompasses
all the unit’s tasks, since members are re-
warded or penalized collectively. Thus, mem-
bers do whatever is necessary to improve
performance rather than only doing “re-
warded” tasks.
In terms of affective problems, the par-
ticipative nature of the PI generation process
usually ensures high levels of intrinsic satis-
faction among unit members. This commonly
manifests itself in increased identification with
the group and in enhanced commitment to
group undertakings. The use of PIs, therefore,
has the potential to enhance cohesion and in-
dividual interest.
Of course, PIs can generate their own set
of unintended consequences. Werther, Ruch,
and McClure (1986, p. 339) offer an example
of this in describing a set of possible PIs for
the service staff of a new restaurant. Table III
contains five possible PIs from many that the
unit might have constructed. If Ratio 5 (Dol-
lar Amount of Food Served/Number of Employ-
ees per Shift) defines unit performance, then
staff is likely to encourage customers to order
both more dishes and more expensive dishes.
If Ratio 4 (Number of Checks/Number of Em-
ployees per Shift) defines performance, then
staff is likely to find ways to write separate
checks for each individual at a table or for each
item ordered. If Ratio 1 (Number of Custom-
ers Served/Number of Employees per Shift)
defines performance, staff will find ways to
discourage customers from lingering. Similar
kinds of implications are associated with the
other PIs.
Thus, although the PIs appear similar,
their implications are different. A careless-
ly constructed PI can have a significant
negative impact on the unit’s mission. Even
appropriate PIs can have inappropriate con-
sequences. For example, Ratio 1 was not
meant to hurry customers but to ensure
prompt and speedy service. As noted earlier,
the use of a family of PIs (in this case, per-
haps Ratio 1 and Ratio 5) can minimize such
unintended consequences.
Finally, the PIs in Table III are all only
“partial” measures. Each is a ratio of output
to just one of four categories of inputs (labor,
material, cost, or energy). Partial measures can
142 • H UMAN RESOURCE MANAGEMENT, Summer 1998

TABLE III Possible Performance Indicators for a Restaurant Service Unit.*

1. Number of Customers Served / Number of Employees per Shift

2. Number of Meals Served / Number of Employees per Shift
3. Number of Tables Served / Number of Employees per Shift
4. Number of Checks / Number of Employees per Shift
5. Dollar Amount of Food Served / Number of Employees per Shift

* Adapted from Werther et al., 1986.

fail to detect important trade-offs. If the unit
is purchasing speedy service at the cost of in-
creased spoilage of material, this trade-off may
not be detected even by a family of PIs such
as those in Table III. Because those PIs are
all partial measures focused only on labor, the
group needs to include one or more PIs fo-
cused on material as input. Table IV contains
such a family of partial measures developed
for a sales unit.
Discussion
Although the use of PIs appears to alleviate
many merit pay difficulties, an analyst might
raise at least two concerns. First, the approach
ignores individual performance. If merit
pay’s purpose is to motivate the individual, the
suggested scheme may discourage outstand-
ing individual performers since their efforts
go unrewarded in an average performing
unit.
Second, group evaluation may solve the
problems discussed earlier only by elevating
those problems to the work unit level. If so,
the firm still has to grapple with the issues.
These important criticisms are examined
below.
Non-Representative Individual Performance
The norm of distributive justice argues that an
individual should be rewarded in proportion to
his/her contribution. In many situations, the use
of unit PIs will violate the norm. Employees who
are not representative of their unit (both stars
and social loafers) will receive more or less than
their individual efforts truly warrant.
This raises a question as to whether the
elementary unit of the firm is the individual
or the work group. Although noted theorists
(e.g., Likert, 1967) have periodically champi-
oned the work unit, firms hire individuals, not
groups, and individuals see themselves as con-
tributors distinct from the work unit. None-
theless, the success of the firm rests squarely
on group performance. In this light, the firm’s
traditional concern with recognizing and re-
warding individual merit is misplaced. If the
work unit is at the core of achievement, then
the firm’s central reward and recognition ef-
forts must also be at this level.

TABLE IV Family of Possible Performance Indicators for a Sales Unit.*

1. Sales / Number of Employees

2. Sales / Employee Compensation Costs
3. Sales / Material Costs
4. Sales / Units of Energy Consumed
5. Sales / Plant and Equipment Costs

* Adapted from Werther et al., 1986.


For stars, this orientation requires a
change in how they view personal accomplish-
ment. Under the old system, accomplishment
merely entails being good at one’s task. With
PIs, it now also entails being good at helping
others be good at their tasks. By creating this
mind-set among employees, the apparent vio-
lation of distributive justice is much reduced.
At the other extreme, work unit dynamics
often develop that prevent distributive justice
violations through social loafing. In addition
to experiencing monetary and social pressure
to perform acceptably, individuals often en-
counter an element of ego. Unit members can
typically identify individuals whose perfor-
mance is continuously below par, and few in-
dividuals want their cohorts to view them as
incompetent.
Work Unit Level Problems
The second concern is that PIs create regres-
sion problems: Issues resolved at the individual
level reappear at the group level. Instead of
problems centered on individual task interde-
pendencies, the firm now faces problems fo-
cused on group interdependencies; or, instead
of individual complaints about reward ineq-
uities, criticisms now arise from work units.
These concerns are partially justified. In
solving one set of difficulties PI systems may
create others. The firm still benefits, however,
because problems at the group level are likely
to be fewer in total (given the smaller number
of units involved) and more noticeable. Since
a specific problem necessarily affects a larger
organizational unit, it is less easily missed or
ignored (cf., Brown, 1984; Gomez-Mejia &
Balkin, 1992). Thus, the firm has a better
chance of detecting and correcting merit is-
sues at this level.
Transitioning to Group Performance
Management
In moving to PIs, firms must carefully con-
sider the transition from one system to an-
other. As noted earlier, group members
typically are heavily involved in the develop-
ment of a PI system, so transitional processes
begin with this stage and continue until
Merit Pay, Performance Appraisal, and Individual Motivation • 143
acceptable PIs have been created. At this
point, what then happens? Does the firm ease
into the new system or does it completely aban-
don its individual performance system for the
new approach?
Easing into the new procedures (e.g., by
augmenting the existing system with the recently
created PIs) has several benefits. The company
minimizes disruption and gets a chance to test
the new PIs. Further, some experts (e.g.,
Heneman, 1992) have argued that using such
hybrid systems is highly appropriate. Since dif-
ferent performance management systems serve
different purposes (e.g., one motivating groups;
another, individuals), a firm may find it useful
to have multiple systems in place. For example,
Pacific Gas and Electric (1989) has performance
systems that reward corporate, work group, and
individual achievement; and, similarly, Lincoln
Electric manages performance through a com-
bination of individual and group level evalua-
tions (Lienert, 1995; Perry, 1990; see also Shaw
& Schneier, 1995).
Nonetheless, a firm must carefully exam-
ine this intuitively appealing notion. Conflicts
among different reward systems often cause
problems with traditional merit approaches, and
these difficulties may hamper a formal hybrid
system. Multiple systems, with their different
emphases, can create confusion and conflict
without extremely careful management.
Companies may find an alternative strat-
egy useful. Management must first fully ex-
amine the implications of a PI system to
ensure its compatiblity with both organiza-
tional culture and employee expectations.
Then, having developed PIs, units should track
performance for several quarters, ensuring
that the system functions as expected. Finally, As noted earlier,
group members
the work groups should switch completely to typically are
the PI system on a date they previously deter- heavily involved
mined. This kind of transitional approach, al- in the
lowing the groups to determine the development of a
change-over period, makes use of the team- Performance
Indicators (PI)
building potential inherent in a PI system, and system, so
also avoids the problems associated with mul- transitional
tiple performance management systems. processes begin
with this stage
and continue
until acceptable
Conclusion
PIs have been
created.
To remain competitive, a firm needs to entice
employees to perform at their best. While
144 • H UMAN RESOURCE MANAGEMENT, Summer 1998

merit pay plans appear to represent one pow-
erful and intuitively appealing enticement, for
a substantial number of firms using such
plans, the reality is much different from the
appearance. A unit-level merit system based
on PIs, while not as intuitively obvious, po-
tentially has a great deal to offer. Companies
dissatisfied with the traditional merit approach
may wish to explore this alternative.

DONALD J. CAMPBELL, an associate professor in the Department of Organizational Behavior

at the National University of Singapore, received his doctorate from Purdue University. He
taught at the University of Iowa, Bowling Green State University, and Duke University be-
fore joining NUS. His research has appeared in many of the major scholarly journals, in-
cluding the Academy of Management Journal, Academy of Management Review, and Journal
of Applied Psychology. A licensed psychologist, he is a member of the Academy of Manage-
ment, the American Psychological Society, the Singapore Institute of Human Resource Man-
agement, and the Singapore Training and Development Association.

KATHLEEN M. C AMPBELL is a senior lecturer of Organizational Behavior at the National

University of Singapore. She received her doctorate in psychology from Purdue University
and has taught at the University of Iowa, Duke University, and Bowling Green State Univer-
sity. Her other research interests include career development, work-family issues, and the
management of expatriates. She has published in the Journal of Applied Psychology, Journal
of Occupational and Organizational Psychology, Educational and Psychological Measurement,
and Human Resource Management. She conducts executive development programs in hu-
man resource management, career development, and cross-cultural management.

HO-BENG CHIA is a lecturer at the National University of Singapore and teaches organi-
zational behavior, human resource management, creative problem solving, and negotia-
tions and mediation. He received his doctorate in organizational behavior from the Univer-
sity of British Columbia. His research interests include goal setting and motivation, conflict
management, cross-cultural differences in organizational behavior, and organizational
effectiveness.

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