The paper discusses several key theoretical issues of eco-compensation. Xunyang County in Shaanxi Province, water source areas along South-to-North Water Transfer Middle Line is selected as an example, including the concept of eco-compensation, why should it be done, who should be the main stakeholders to provide the compensation and who should be the main stakeholders to accept the compensation, how much should it be paid and how to compensate, etc. The eco-compensation is a kind of institution arrangement, which is to internalize the externality of the ecological environment, and finally achieve the purposes of conserve the ecological environment and promote the increment of natural capital and ecological service function. Its essence is to adjust and improve the relevant social production relationship in the field of natural resource exploitation and ecological environment conservation, and finally promote the development of natural resources and environment as well as the social productivity. The paper believes that the inequity of the development rights between the upstream and downstream of the watershed caused by the difference of the original allocation of the environmental and natural resources rights should be compensated via the eco-compensation mechanism; the local and central government along the downstream of South-to-North Water Transfer Middle Line should be the main stakeholders who providing the compensation, and the local government, legal entity and community residents of the water source areas of the upstream should be the main stakeholders who should enjoy the compensation; the scope and standard of the eco-compensation could consist of two components, the extra costs arising from ecological protection and construction and the opportunity costs of sacrificing development chances. In the context of imperfect allocation of the environment and natural resource property rights and lack of market-based mechanism, the intervention and control of the central government on the eco-compensation should be strengthened. Under the condition of clear definition of property rights and high extent of market-based economy, the mechanism of volunteer negotiation and market transaction among the stakeholders could be gradually established. In the process of the implementation of the concrete eco-compensation policies, the policy maker should pay more attention to create the development opportunity, space and policies for the local government and community; the approach and method of the eco-compensation should be diverse; meanwhile, the monitoring and supervision, evaluation and incentive mechanism on the eco-compensation enforcement as well as the reasonable officials assessment mechanism should be established.