Employee Reviews and Grading Medians

I've been reviewing employees using a certain grading system for some time now. I belong to the school of thought that ascribes to "tough love", ie grading systems should be anything but lenient. So for a grading system that rates out 5, the following is the criteria:

1. (1)Very poor job: Need to be caught sleeping more than once on the job to get this!
2. (2)Poor job: Not satisfied with the performance
3. (3)Meets job requirements: Typical grade for a ok job done
4. (4)Above Average: When there is something really good about how the job was done (expect around 10% of the employee base to be here)
5. (5)Exceptional: If I somehow hired James Gosling who rewrote the whole corporate strategy! (extra credit - dont expect anyone to be here unless they're a class apart)

So during December's review cycle, I got hit by a thought - why must I always have to argue with employees who claim they've earned a "4" when I'm giving them a "3.5" or so. To me a number like 3.5 is good, but to a majority its poor and they walk away from a review demoralized. Since I've worked in larger organizations where a standard is followed and any issues are to be taken up with HR, I've never thought on this much. But now, working in a smaller organization gives a whole new meaning when I see a majority thats demoralized.

Thought: Should grading be lenient
Advantages
1. Everyone comes out as a winner - We live in a society where every other parent has a "proud parent of an honor student" sticker on their car's bumper (not in Pakistan as yet, but the mindset is the same). Its not possible for all students to have become smart, lowering of the grading system and instilling this thought in the masses is a far more likely cause. Why swim against the tide?
2. Motivated employee base - the purpose of a review is to improve employee productivity IMHO. It requires that we identify the shortcomings and highlight the positives. However if the end grade is considered demeaning we can forget about a motivated and hence a productive employee base (outside of the 10% employees who get 4 or over).
3. Easier time for the grader - we too are human beings and arguing takes out our positive energy. Trying to argue with someone on why its not a low grade but how its a decent grade leaving room for improvements until the next review sometimes feels like a bad hair day!

Cons:
1. Incorrect messaging - It is important for individuals to understand they have shortcomings. A high grade may misguide an employee into a comfort zone where only larger trouble lays ahead, either for the employer or the employee.


I'd love to hear your thoughts on whether my grading system should be changed such that a 5 stands for a very good job rather than exceptional with appropriate adjustments to the other numbers.