diff --git a/builtin/merge-file.c b/builtin/merge-file.c
index b6664d49be9..6c4afb5a38b 100644
--- a/builtin/merge-file.c
+++ b/builtin/merge-file.c
@@ -28,6 +28,7 @@ int cmd_merge_file(int argc, const char **argv, const char *prefix)
 	xmparam_t xmp = {{0}};
 	int ret = 0, i = 0, to_stdout = 0;
 	int quiet = 0;
+	int prefixlen = 0;
 	struct option options[] = {
 		OPT_BOOLEAN('p', "stdout", &to_stdout, "send results to standard output"),
 		OPT_SET_INT(0, "diff3", &xmp.style, "use a diff3 based merge", XDL_MERGE_DIFF3),
@@ -65,10 +66,14 @@ int cmd_merge_file(int argc, const char **argv, const char *prefix)
 				     "%s\n", strerror(errno));
 	}
 
+	if (prefix)
+		prefixlen = strlen(prefix);
+
 	for (i = 0; i < 3; i++) {
+		const char *fname = prefix_filename(prefix, prefixlen, argv[i]);
 		if (!names[i])
 			names[i] = argv[i];
-		if (read_mmfile(mmfs + i, argv[i]))
+		if (read_mmfile(mmfs + i, fname))
 			return -1;
 		if (buffer_is_binary(mmfs[i].ptr, mmfs[i].size))
 			return error("Cannot merge binary files: %s\n",
diff --git a/setup.c b/setup.c
index a3b76de2bb1..346ef2eb2d6 100644
--- a/setup.c
+++ b/setup.c
@@ -46,7 +46,7 @@ const char *prefix_filename(const char *pfx, int pfx_len, const char *arg)
 {
 	static char path[PATH_MAX];
 #ifndef WIN32
-	if (!pfx || !*pfx || is_absolute_path(arg))
+	if (!pfx_len || is_absolute_path(arg))
 		return arg;
 	memcpy(path, pfx, pfx_len);
 	strcpy(path + pfx_len, arg);
@@ -55,7 +55,7 @@ const char *prefix_filename(const char *pfx, int pfx_len, const char *arg)
 	/* don't add prefix to absolute paths, but still replace '\' by '/' */
 	if (is_absolute_path(arg))
 		pfx_len = 0;
-	else
+	else if (pfx_len)
 		memcpy(path, pfx, pfx_len);
 	strcpy(path + pfx_len, arg);
 	for (p = path + pfx_len; *p; p++)
diff --git a/t/t6023-merge-file.sh b/t/t6023-merge-file.sh
index d486d73994c..d9f343942c7 100755
--- a/t/t6023-merge-file.sh
+++ b/t/t6023-merge-file.sh
@@ -64,6 +64,14 @@ cp new1.txt test.txt
 test_expect_success "merge without conflict" \
 	"git merge-file test.txt orig.txt new2.txt"
 
+test_expect_success 'works in subdirectory' '
+	mkdir dir &&
+	cp new1.txt dir/a.txt &&
+	cp orig.txt dir/o.txt &&
+	cp new2.txt dir/b.txt &&
+	( cd dir && git merge-file a.txt o.txt b.txt )
+'
+
 cp new1.txt test.txt
 test_expect_success "merge without conflict (--quiet)" \
 	"git merge-file --quiet test.txt orig.txt new2.txt"