What are the limitations or drawbacks of a performance appraisal system ?

The main challange associated with target setting or performance based pay system is Negative Behavior for example; Tunnel Behaviour, Gaming, Sand Bagging and Unethical Behaviour. To avoid these the performance management system must be cascaded from top to bottom and SMART targets must be set. If your performance appraisal system emphasizes more on contineous improvement than rewards or performance based pay then you dont need to worry about the drawbacks. 

Getting the right data quality dimenssions (data availablity, data acuracy, timeliness and completeness) is also a tough task on or before performance review meeting.

For better understanding please ready below real life example;

Atlanta Public Schools, a school district based in Atlanta, Georgia, USA. 2001-2011

Atlanta Public Schools experienced unusually high gains in standardized test scores, during the 11-year tenure of former Superintendent Beverly Hall.

In 2009, the Atlanta Journal-Constitution began investigating these high scores and suggested there was evidence of cheating. Therefore, in 2010, tests were administered under much higher scrutiny and the scores dropped dramatically.

A major investigation was launched by the state of Georgia. The report of the investigation named 178 educators, including 38 principals, as participants in cheating. Teachers and principals erased and corrected mistakes on students’ answer sheets, thus transforming testing failures into successes, in order to meet the District’s imposed targets.

Reason, “The district set unrealistic test-score goals, or targets, a culture of pressure and retaliation spread throughout the district, and caused unethical behavior”.