The operation of a merit pay plan depends on the effectiveness of the performance appraisal system.

Merit pay plans are based on the premise that employees who perform better should be rewarded with higher pay. The effectiveness of this plan depends on the accuracy and fairness of the performance appraisal system, which determines the level of performance of each employee. If the performance appraisal system is flawed, the merit pay plan will also be flawed, as it will not accurately reward employees based on their performance. Therefore, the operation of a merit pay plan is dependent on the effectiveness of the performance appraisal system.