It's an interesting idea and not that uncommon in other sectors. Athletic coaches have bonuses written into their contracts for winning a certain number of games or winning championships. Salesmen live and die performance pay in the form of commissions. And, just today, I was in a meeting discussing how to train museum educators where someone proposed that we create monetary incentives for museum staff who interact with a certain number of patrons. In short, whether we're a parent trying to get a child to do something they may not do on their own--eat their vegetables, mow the lawn, or get good grades--or a manager trying to improve the performance of an employee, incentives are part of the world we live in and can lead to a variety of positive behaviors.
The trouble is that, at times, the incentives or reward structures we put in place are actually incentivizing a set of behaviors very different than what we would hope for. And, in settings where innovation or creativity are highly valued, performance-based pay has the potential to discourage the calculated risk-taking necessary for make improvements and breakthroughs to occur. In the case of British vice-chancellors, their governing bodies need to think carefully about what they value in leaders and what constitutes success or "high performance" and then carefully craft their incentives and performance-based pay criteria in alignment with those values. If what the performance indicators are in conflict with other values, there will be trouble and the government might get something completely different than what they expected when they set out to improve the "performance" of high-level administrators.
Compensating or rewarding individuals based on performance measures can solve some problems. By identifying desired behaviors and then "paying out" when they are seen with some consistency, people may start to behave differently. But, there are often unintended consequences and we sometimes create new problems in our attempt to solve old ones.