Silicon heat transfer compound(Thermoconductive paste) is a silicon based paste used to lower the thermal resistance between a semiconductor and a heatsink. Since the surface of the semiconductor and the heatsink is not completely smooth there will always be some air between them. This air acts as a heat insulator, and increase the thermal resitance. By applying the compound these holes gets filled in, thus lowering the resistance.

A little story:
A few weeks ago, I was repairing a PC at the place I work Anyway, two others work at the same office as me. They are university educated programmers.
One of them picks up a processor, and starts to play with it. He takes of the heatsink and turns to the other one:
'What's this?'
'I don't know' he answer
Then in a flash of enlightenment the first one finds out what it is; Correction fluid!.

I laughed until i fell of the chair.