According to theories of motivation and common expectation, people who contribute more should receive more. Relative adjustment in pay based on the person's performance forge a link between pay expenditure and individual productivity.
Merit pay approach also has another benefit. It reflects common belief that individuals should be rewarded proportion to their contributions. This reflection captures the feelings of most people regarding pay. In this way, merit pay approach also potentially diffuse concern about fairness and equity.
On the other hand, performance appraisal is the end of a process that goes on all the time - a process that is based on good communication between boss and employee. It has only little direct proportion to the productivity of a worker. So, more time should be spent preventing performance problems than evaluating at the end of the year. When bosses do good things during the year, the appraisal is easy to do and comfortable, because there won't be any surprises.
To conclude, merit approach appears to be a powerful and intuitively appealing enticement compare to performance appraisal method. Companies having problem in motivating their employees may wish to explore this approach.