This dissertation examines the diffusion of performance-based funding policy in higher education based on the conceptual framework of policy innovation and diffusion. After examining the two waves of state adoption of this policy, 1979-2002 and 2003-2014, I argue that during the first period, regional influence, state fiscal condition, educational attainment, tuition change, and higher education governance are the main factors that lead to state adoption of the policy. States with higher probability of adoption tend to have more adopting neighbors, better fiscal condition, higher educational attainment rates, tuition decreases, and an absence of a consolidated governing board. From 2003 through 2014, states with declined college enrollment and conservative governments appear to be more likely adopters. Further, evidence suggests that the non-adoption of performance funding is not simply attributed to the perceived image of the policy or the level of knowledge of the innovation. State higher education finance requires collective efforts from the higher education governing agency, the executive, and the legislature. Finally, higher education institutions also partially determine the budgetary decisions by providing their inputs.