Public debate over higher education has changed from questions about education, learning, scholarship, and professional service to performance criteria measured in quantitative, business-like indicators, such as revenues and costs of operation. The rules have changed, and new consumers have new concerns and challenges for higher education. Faculty compensation is one means an institution can use to achieve its mission, and it is a management tool academic administrators can use to meet external demands for cost control, faculty performance, and institutional quality. This report focuses on: (1) the link between the faculty compensation system and its impact on institutional mission and quality; (2) the external and internal factors affecting the amount of faculty compensation; (3) changes in absolute and relative levels of faculty compensation over time and economic factors affecting these changes; (4) the different types of compensation systems used; (5) the intellectual rationale of the two compensation systems used most often; (6) operational advantages and disadvantages of the faculty compensation systems; (7) development of an effective faculty compensation system; and (8) the types of systems recommended for different institutions. Appended are: Illustrative Criteria for Faculty Merit Awards and Evaluation Tool for Satisfactory Faculty Standards. Name and Subject Indexes are also included. (Contains 100 references and 6 tables.) (SLD)