The supervisory boards of Europe's biggest auto giant Volkswagen and luxury car maker Porsche said on Thursday they had approved a plan to merge their two companies by 2011.
VW, Porsche merger - details
Under the terms of the agreement, Volkswagen will initially buy a 42% stake in Porsche by the end of 2009 for 3.3 billion euros (4.7 billion dollars) in a deal valuing Porsche at 12.4 billion euros, the companies said.
Volkswagen will then increase its capital in the first six months of 2010 by issuing new preferred shares and Porsche will increase its capital in the first half of 2011 by issuing ordinary and preferred shares.
The deal comes after months of complex and acrimonious negotiations.
Volkswagen eked out a net profit in the second quarter despite a collapse in demand for cars due to the global economic crisis and it plans to become the world's biggest automaker by 2018 by overtaking Japan's Toyota.
The group will now work to integrate Porsche as its 10th brand, alongside the Audi, Bentley, Bugatti and Lamborghini marques, although the companies stressed on Thursday that Porsche would remain an "independent" brand.
The plan seals the failure of a gamble begun by Porsche's management last year to take over the far larger VW in what would have been one of the most spectacular corporate operations in German history.
The deal also marks a victory for VW chairman Ferdinand Piech, grandson of the inventor of the VW Beetle and nicknamed "the patriarch" by German media, who has been planning the tie-up with Porsche for years.