The 59-year-old Chilean had been courted for months by City following impressive spells in Spain with Villarreal and Malaga. He also coached Real Madrid during his nine-year stint in Spain but was fired after one season despite guiding the team to its then-record points total in La Liga.
Pellegrini was appointed exactly a month after Roberto Mancini was fired for failing to capture a trophy in his third full season.
"I am delighted to accept this hugely exciting opportunity," Pellegrini said. "The club has a clear vision for success both on and off the pitch, and I am committed to making a significant contribution."
Pellegrini signed a three-year deal and will start June 24. He will be managing in his fifth country in 25 years, after stints in Chile, Ecuador, Argentina and Spain.
"Manuel is a hugely experienced and successful manager with a proven track record," City chairman Khaldoon Al Mubarak said.
In 2012, City won its first English league title since 1968 but it finished second to Manchester United this year. Pellegrini becomes the third new manager among the English powers after David Moyes replaced retiring Alex Ferguson at Manchester United and Jose Mourinho returned to Chelsea in place of Rafa Benitez.
Pellegrini failed to win a major title during his time in Spain. City executives Ferran Soriano and Txiki Begiristain former Barcelona officials charged with developing City's long-term strategy have turned to a laid-back coach known for his management skills and ability to get the best out of players.
"Manuel is a very experienced coach with a recognized ability to get the most out of his players and build cohesive teams," Soriano said. "He shares the club's approach to football and our ambition to achieve on-field success, coordinating with the wider football support teams to ensure natural progression from the academy to senior level."
Pellegrini overachieved at Villarreal and Malaga, leading the former to the Champions League semifinals in 2006 and the latter to the quarterfinals of Europe's top competition last season. At Madrid, he had little power over roster moves.
Madrid finished its one and only season under Pellegrini with 96 points, a club record at the time, despite being without the injured Cristiano Ronaldo for six weeks. After finishing second to Barcelona in La Liga and getting eliminated in the second round of the Champions League, he was fired and succeeded by Mourinho.
In firing Mancini, City said it wanted a coach who could "develop a holistic approach to all aspects of football at the club," and Pellegrini proved at Villarreal and Malaga that he could integrate youth and spot targets in the transfer market.
City's star-studded squad has been bolstered during the past week by the additions of Brazilian midfielder Fernandinho and Spanish winger Jesus Navas for about $78 million.
"Everything is in place for Manchester City to continue to be successful," Pellegrini said, "and I am excited to be able to work with such a talented squad, the executive team and the board to deliver for fans who are renowned for their steadfast support."