I ran across a great article on the problems created by our common use of performance appraisal today: Unjust Deserts (pdf format) by Mary Poppendieck:
There is no greater de-motivator than a reward system that is perceived to be unfair.
The article does a good job of explaining these, and several more, problems caused by performance appraisal. It also provides some good thoughts on how to manage effectively, including:
People are increasingly challenging the notion that we just have to live with performance appraisal systems. As usually, I will make my suggestion that chapter 9 of the Leader's Handbook offers great material on performing without appraisal (and the rest of the book is great too). More related resources: