This chapter begins by placing merit pay in the broader context of pay strategy. It describes the fundamental policy aspects of a merit pay system, as well as the typical challenges encountered in executing these merit pay policies. The chapter examines the case that merit pay is often defined and studied too narrowly and that a fuller picture is necessary. In most organizations, especially for managerial and professional employees, one element of pay for performance is merit pay. Two basic purposes of merit pay are first, to provide incentives to motivate employees to perform at a high level by recognizing and rewarding performance over time, and second, to build the best workforce possible by attracting and retaining high performers. Merit pay can be said to objectively exist when performance ratings validly differentiate employees performing at different levels and these different performance ratings are positively and meaningfully correlated with salary levels and salary increases.