In many companies, those who have been there the longest earn the most, regardless of whether they contribute the most to the organization. Meanwhile, newer employees who might give their jobs more energy may take home smaller paychecks. On the other hand, companies that have a merit-based pay system in place ensure that employees are rewarded for the value they provide the organization, not how long they’ve managed to keep their jobs.
Merit-based pay is pay based on an employee’s performance. That means that employees who put more effort into their work and perform better at their jobs get rewarded with higher raises and bonuses than those who put in just enough effort to get by.
In a way, merit-based pay is like the carrot dangling in front of you from a stick, motivating you with the idea of a bigger paycheck to do your job better. Of course, the caveat here is that your employer assumes you are motivated by the idea of a fatter paycheck; if you are not money-driven, then a merit-based pay system will fail to achieve its intended goal.
Imagine that it’s annual review time, and you've received a glowing review, while you suspect that the person in the cubicle next to you, who spends a third of his workdays texting and instant-messaging his friends, received a poor review (assuming that your company has an unbiased review system). Yet when it’s time for raises, you both get equal pay increases. Disheartening, right? A merit-based pay system, on the other hand, rewards you for a job well done, and it does so in a way that is commensurate with how much you did or how well you did it in relation to your peers.
For the company, the payoff is increased productivity or higher-quality work from you. So if everyone or nearly everyone within a company strives to consistently do their jobs as well as possible to earn merit pay increases, the cumulative effect for the company would be a significantly healthier bottom line. While you may not care what the company’s stockholders are taking home in dividends, ultimately, a company that performs well is less likely to lay you off.