Many employers attempt to provide some form of “merit”-based pay using performance factors for base pay increases, bonuses, and other forms of compensation. This approach to compensation is typically well-intended. Employers want to motivate employees to improve their performance, to reward high performers, and to attract and retain top talent. Unfortunately, merit increases are a terrible way to try to accomplish those goals. 

While merit pay can, in theory, reward and recognize strong performance to the benefit of employees and the company, the challenge with performance-based pay or any other assessment measure is developing accurate, consistent and unbiased evaluations. In practice, these systems are often poor measures of actual performance that are more risk than reward.

Lack of meaningful distinctions of performance

Managers are often reluctant to identify performance problems or issues and provide good feedback. This can affect the perception of whether a reward system is fair and can lead to score clustering. For example, a five-point system where almost everyone earns 4s, with few 3s and 5s reduces the ability of the score to meaningfully distinguish between strong and weak performers.

Inappropriate or irrelevant criteria

A second problem occurs when employers use criteria that are not appropriate. For example, employers may measure intrinsic traits or generic or irrelevant skills instead of job-related actions and behaviors – or try to evaluate employees with vague or ambiguous measures that require interpretation. While it is possible to create validated systems and processes, using job-related criteria or conducting a formal job analysis can be a complex and costly proposition.

Subjectivity and bias

Too often, merit increases are subjective and are not linked to performance scores, which may themselves reflect subjective biases. As such, merit increase practices do a poor job at measuring performance. Common performance review systems and evaluation practices can result in biased decisions, including rating performance by Black employees lower than comparable performance by white employees, evaluating women and men differently for similar performance, or providing women or employees of color lower rewards than white men for similar scores where there is discretion or a range of potential rewards. Studies have outlined the various ways that subjectivity in performance assessments can impact women and people of color. 

Merit-based pay can also exacerbate the problem of in-group favoritism. Supervisors may be more likely to provide higher ratings for employees they like or who have similar backgrounds or experiences. Basing pay increases on biased performance assessments can create unlawful pay disparities and exacerbate existing pay inequity.

Performance evaluations often perpetuate race and gender biases, making it harder to achieve pay equity and to align pay programs with values. In our experience conducting assessments of all kinds of workplaces, we have often seen merit increases and other performance-based pay practices as a key factor in race-based and gender-based pay differences. They can also make it difficult to provide transparency around pay practices and decisions about increases.

Unintended consequences for morale

Merit pay systems usually feature time-consuming bureaucratic structures that managers and employees hate. Efforts to incentivize performance by tying it to compensation can be counter-productive, by contributing to job dissatisfaction and lowering morale for those who are not selected for pay increases – particularly if they question the fairness of subjective assessment practices. As a result, merit pay systems fail to motivate, reward and retain the best workers.

Compounding effect for pay inequity

Merit increases based on a biased performance assessment can have a compounding negative effect on employee compensation over time. By contrast, a one-time bonus to incentivize and reward strong performance may have less risk of embedding bias into salaries going forward. (However, the metrics used to award bonuses should still ensure consistent, accurate and unbiased assessments as much as possible.)

A Better Approach

At Working IDEAL, we advise clients seeking to strengthen equity and transparency in their pay practices, and we believe traditional merit increases are inconsistent with those key values. These approaches can reflect and amplify race and gender bias in performance assessment measures, leading to disparities in pay based on gender, race, and other protected characteristics. To incentivize strong performance while also mitigating the risks of bias and favoritism in compensation, employers should take the following steps:

Use objective performance assessment measures. Performance assessment measures should be based on objective, clear, and measurable criteria that relate to the job. Employers should avoid using subjective criteria, such as personality or attitude, which can be biased. Regular, informal check-ins provide an opportunity for supervisors to provide substantive feedback in real time and can be more effective than annual performance reviews.

Regularly review performance assessment measures for bias. Employers should regularly review their performance assessment measures to identify and eliminate any potential bias. The performance assessment process and review should involve input from employees from a variety of backgrounds. Data on performance ratings should be analyzed regularly to identify and address potential disparities based on protected characteristics, such as gender-based or race-based differentials.

Provide training to managers on unconscious bias. Managers should be trained on unconscious bias so that they are aware how their own biases can impact their performance assessments.

Implement a transparent and fair pay system. Employers should utilize a clear and transparent pay system that is based on objective criteria. Compensation should be reviewed regularly to ensure that it is fair and equitable. 

Consider alternatives to merit-based pay increases. While merit-based pay is intended to motivate employees to do their best work, rather than the bare minimum, employers should keep in mind that merit-based pay is not the only way to motivate employees and reward them for their performance. 

Employers should provide promotion opportunities for strong performers to grow and advance. Typically, promotions should come with a pay raise. Training and professional development opportunities can provide a means for strong performers to develop their skills. 

Non-monetary rewards can also be effective in motivating employees. For example, employers can reward high performers with public recognition, time off, or a celebratory lunch for a team that completed a successful project. Celebrating successes helps to create a culture of recognition and appreciation, which can boost morale. By using a variety of rewards and recognition strategies, employers can create a more equitable and inclusive workplace while also reinforcing employees’ contributions to foster a motivated and engaged workforce.

While employers may have a vested interest in incentivizing and rewarding strong performance, employers must be aware of the risks of bias and favoritism in merit-based pay systems. Employers can mitigate these risks by implementing best practices to eliminate bias in compensation and performance review policies and practices.

Working IDEAL provides trusted and innovative advice on inclusive workplaces, diverse talent, and fair pay. Our audits and assessments apply the best thinking on how to promote gender, race and other forms of equity in your pay practices. Our robust quantitative and qualitative reviews go beyond basic compliance to align effective compensation strategy. Let’s connect.