Abstract: As a new salary distribution system, annual compensation system is employed to encourage the managers to improve the performance, which is proven to be a perfect way to solve the principal-agent problem. And nowadays, more and more policy makers are tend to carry annual compensation system in public hospital reform to strengthen the welfare and efficiency of public hospitals. This paper firstly introduced the concept of annual compensation system. And discussions were carried out on the necessity and feasibility of annual compensation system in public hospitals. Finally, due attention should be paid to three issues: how to fill the funding gap of salary, how to promote the enthusiasm of service provision and how to avoid unreasonable behavior of service providers.