My opinion: annual performance reviews are hammers looking for nails to pound, and hurting employee engagement, productivity and health in the process. If you have any say in the matter, please throw out your performance review process.
Here's why I believe that, and some alternatives you might want to try.
The purposes of annual performance evaluations (at least according to Patricia Buhler, in her book Human Resources Management) are to improve employee performance and to provide "data" for decisions about promotions, transfers, terminations, salary increases and bonuses.
Unfortunately, research shows that annual performance evaluations - as implemented at most organizations - don't accomplish any of these objectives. Instead, these annual rituals cause harm to individuals and to companies. See Sutton and Pfeffer's Hard Facts, Dangerous Half-Truths And Total Nonsense: Profiting From Evidence-Based Management, for more on this (especially page 126).
Bob Sutton reminded me of the harm performance reviews do in his February 16 blog on the topic. As he and Jeff Pfeffer noted in their 2000 book, The Knowing-Doing Gap: How Smart Companies Turn Knowledge into Action, performance rankings can lead to destructive internal competition (p. 179), which can make it tough to build a culture of knowledge sharing (p. 190). In addition, there seems to be a self-fulfilling prophecy at work, in which a person receiving a poor evaluation does even worse in the subsequent rating period (p. 193). On top of that, annual performance review systems consume valuable management time, increase stress (for both the hammer and the nail), and instill a culture of defensiveness (especially if pay is linked to performance evaluations.
Not the best atmosphere for improving performance.
What to do in order to improve employee performance
Above all, do no harm. That means throw out that awful annual performance evaluation system.
In its stead, put in place a process that helps employees improve their own performance. Get clear on expectations. Give recognition and praise when things go well. Meet regularly to discuss progress and find out what barriers you need to bust in order to facilitate success. Remember that most performance issues are due to system failures, rather than people failures. (Or, as Sutton and Pfeffer put it on page 101 of Hard Facts, "The Law of Crappy Systems Trumps the Law of Crappy People.") Root out and fix crappy systems and your employees will perform much better.
In addition to frequent ad hoc feedback, meet at least monthly with each person on your team. Here's a process that I find works quite well for that monthly coaching session.
Listen to your gut. Most of you dread the annual performance review chore - even those of you in HR. You probably grumble about it around the water cooler. Why? Because it is an awful approach to employee development. Kill it! And replace it with real, frequent conversations with the folks on your team.
You'll be happy you did!