When the search engine spiders crawl a site they follow the links on the page, provided that they are not directed by HTML code not to. A vote is counted for each link they find pointing to a site. These votes tally up to equal the PR for the site. Actually there is more to it than just that but in a nutshell, this is how it works.
Each link to your homepage or another page on your site will add a bit to the PR. The PageRank of the linking site is factored into the formula, so not all votes are equal. The linking site is sort of sharing their PR with you. The vote carries more weight when it comes from a high PR site. This doesn't mean that a link from a PR1 site will somehow hurt your PR as some would have you believe. In general, a link pointing to your site will not reduce your PR.
This is not necessarily the case with outbound links from your site though, so you need to be careful who you link to. Before I get too deep into that, let's take a step back and discuss some common ways sites develop links, then we can cover the pitfalls.
One fairly common method of getting links to your site is through link exchanges. Basically you put a link on your site and another webmaster adds a link to your site on one of their pages. It is not a good idea to link from a site with huge link pages full of unrelated links. The "vote" would be so diluted from the other links so as to be almost meaningless. A more important point is simply if you link to a banned site, your site will be penalized for doing it. This will kill your PageRank!
It is a good practice to check all of your linking partners at least monthly to make sure of two important things. First, make sure they are still linking to you. Second, make sure they have not been banned. If you find they have deleted your link, ask them to replace it. if however, you find that the other site has been banned you should immediately remove their link from your site. If you continue to link to a banned site, your PR will suffer.
Linking is an important SEO strategy and as long as you keep an eye on your link partners it makes sense to exchange links. Here is a better plan to put in place, generate one way links back to your site. These are links that other sites put up that point to your site without you having to link to them. One way links can be developed in a variety of ways. Keep in mind that, because you have no control over them they can not hurt you. below are four quick tips to get one-way links.
1. Post comments on public forums, articles, blogs, etc. with a link to your site.
2. Submit your original content to social bookmarking sites like StumbleUpon, Technorati, or any of the hundreds of other social sites on the net.
3. Submit articles on your topic to article databases and include a link to your site in the article resource box.
4. Pay for them. Although this is not my favorite way to develop them, it is available.
When you develop a linking strategy and stick to it you will quickly develop more links to your site than you would think. This will improve your PageRank, and it will help drive traffic to your site.