The new system is expected to increase the number of heads receiving performance-related pay ahead of the introduction of a similar structure for all teachers in September 2000.
Although governors are currently asked to link heads' pay to their performance, many governing bodies are reluctant to do so.
The guidelines say the targets in a school's development plan will be the main indicators of performance.
"The key criteria are likely to be pupil progress and school leadership and management. Other criteria -- responsibilities of the post, the social, economic and cultural background of the pupils and whether the post is difficult to fill -- will only be applicable if they have changed substantially during the year."
The proposals abolish the existing system of grouping schools by size to determine heads' pay, replacing it with eight groups based on pupil numbers at various key stages.
David Hart, general secretary of the National Association of Head Teachers, said: "The targets themselves have been the subject of intense negotiations.
"We have succeeded in limiting the reference to targets for the heads' management and leadership or the progress of the pupils. Now, the key issue is what salary ranges the governors will put their headteachers on."
John Dunford, general secretary of the Secondary Heads Association, said: "We were led to expect extra money for implementing the Green Paper, but most heads only got 1.5 per cent above the annual award this year. Also if heads are to be paid for performance, the money must be in the budget."
The heads' pay circular follows on the heels of a Green Paper progress report that revealed very little change in long-term plans on teachers' pay and conditions.
The small print of the report included some slight changes of emphasis: pound;800-pound;1,000 for those above the senior teacher "threshold" instead of the pound;400 originally proposed. This reflects the greater emphasis on rewarding classroom performance rather than management responsibilities. The report also confirmed that there would be no change in senior teachers' contracts.