Advantages and Disadvantages of Merit Pay

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Merit pay is an approach to compensation that rewards higher-performing employees with additional pay, sometimes called incentive pay. It is a tool that employers can use to make sure that their best-performing employees feel as if they are adequately compensated for their contributions.

Merit pay has advantages and disadvantages for both employees and employers over a traditional pay system that puts the money in base pay. Before opting for a merit pay system, it's a good idea to review the advantages and disadvantages of this approach.

Advantages and Disadvantages of Merit Pay

  • Communicates company objectives

  • It lets employees know where they stand

  • Aids in employee retention

  • Concerns about favoritism may arise

  • Time and resources may be better spent elsewhere

  • Communication issues

Advantages of Merit Pay

A merit pay system is most applicable when detailed data is available to measure the performance of employees. Consider how that data can push you as an employee to achieve more and pad your own paychecks before joining a company that offers merit pay.

Communicates Company Objectives

Merit pay sends a powerful message about how the company wants to see employees perform and what it wants to see them contribute. It confirms what it most values from employees. Merit pay also provides a vehicle for your employer to recognize individual performance on a one-time basis. This is useful for rewarding employees who may have participated in a one-time project.

It Lets Employees Know Where They Stand

Making the range of the available merit pay public to employees lets them see where their increase falls on the scale established by the company. It can be a good way to reward and retain employees. When you receive less than the top increase, supervisors have an opportunity to describe and discuss exactly what you will need to do to improve your performance to qualify for the top merit increase during the next cycle of raises.

Aids in Employee Retention

Merit pay can help your company differentiate between the performance of high- and low-performing employees and reward the performance of the higher performers. This may entice you to stay at the company longer because no employer wants to lose the organization's best performers. If that's you, you'll likely be rewarded for your work.


In order to be eligible for a merit pay increase in salary or bonus, you may have to be at a company for a certain period of time, such as six months or one year.

Disadvantages of Merit Pay

Some businesses are not conducive to measuring employee contributions so clearly and definitively, making it difficult to establish an effective means for merit pay. Consider whether or not the company you work for or want to work for is forcing such a system into an environment where it won't work.

Concerns About Favoritism May Arise

In many offices, the value of any particular employee is subjective and ultimately determined by a supervisor. Without clear measurables, other employees could dispute the merit pay you earn. Even in offices where there are measurables, outcomes can be challenged. For example, some might argue that the salesperson with the best sales had an advantage because they were assigned to the best sales territory.

Time and Resources May Be Better Spent Elsewhere

The amount of time and energy that organizations invest in an attempt to make performance measurable for merit pay, including developing competencies, measurements, baselines for performance, and so forth, may be better spent on delivering service to customers. Organizations have generated documents with several hundred pages that lay out what merit means in various jobs. Often, the benefits just aren't worth all that time and effort. That leaves room for the company to change its payment system in the future if it needs to reallocate funds.

Communication Issues

Given the limitations of metrics, the ability of a supervisor to communicate to each employee the value of their contribution, and what superior performance entails that makes it worthy of merit pay consideration, is an ongoing challenge. Some supervisors communicate better than others, and this means the effectiveness of merit pay sometimes can vary wildly from one department to the next based on the communications skills of supervisors.

Frequently Asked Questions (FAQs)

What is merit pay?

Merit pay is when you're paid for the work you do, but the amount is based on your performance. The more work you do and the more often you exceed expectations, the more money you can receive. Some companies pay employees based on their merit, while others may offer salaries and increases based on cost of living, experience, and education.

How does merit pay differ from a bonus?

Merit pay is based on an employee's performance. A bonus may also be based on an employee's performance. A bonus is usually given at certain times (such as on an annual basis) and it case be based on your performance. If you're a high-achiever or top-performer, you could receive a merit-based bonus. On the other hand, general merit pay could simply be an increase in your salary.

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The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.
  1. U.S. Department of Labor. "Merit Pay."

  2. Southern Methodist University. "Merit Increase Process and Guidelines."

  3. U.S. Department of Labor. "Fact Sheet #56C: Bonuses under the Fair Labor Standards Act (FLSA)."

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