Gates, 44, said he will remain as chairman and fill a new post created for himself: chief software architect. He also said in a statement that Ballmer will become a member of the Microsoft board of directors Jan. 27.
Although Gates' decision to hand the CEO duties to Ballmer had long been anticipated, the timing of the announcement was not expected. Gates waited until after the completion of Windows 2000, which will ship next month, before making the change.
In the October issue of Forbes magazine, which ranked the country's richest people, Gates was quoted as saying, "No one should doubt that (Ballmer is) number two in the company. Steve is my best friend." In an interview published the following month, Gates added: "We're both pretty good about being two people with one huge job. Who has what title isn't a phenomenal element of that."
The changing of the guard is taking place at a tumultuous time for Microsoft. Just yesterday, news leaked that the Department of Justice is proposing a breakup of Microsoft to help resolve the antitrust case pending against the company.
Those who know Gates say it would be a mistake to assume that he is abandoning the company he founded in its time of need, believing that he will continue working behind the scenes to thwart his antagonists. At the very least, however, the end of his tenure as chief executive is of much symbolic value to those who have witnessed the astounding ascent of Microsoft and technology in general.
As for Ballmer, those within the company and throughout the industry believe that Microsoft enemies will find him an equally formidable adversary. During a press conference at company headquarters in Redmond, Wash., Ballmer made it clear the government has no business breaking up his company.
"I think it would be absolutely reckless and irresponsible for anyone to try and break up this company," he said at the news conference. "I think it would be unprecedented, and I think it would be the single greatest disservice that anybody could do to consumers in this country--it would be reckless beyond belief."
In a conference call following the announcement, Ballmer bristled at rumors that the government planned to break up Microsoft. He said he believed government sources leaked the rumors to the press.
"Yes, I believe the leaks are deliberate," he said. "I don't think there's any doubt about that; not only the leaks but the entire line of conjecture is reasonably reckless and irresponsible."
As Ballmer brandished the corporate sword, Gates' comments seemed far more reflective, befitting those of a man looking forward to spending more time with his true passion: software.
"I've been chatting with Steve and the board with (the idea of) getting myself focused on products for a couple of years," Gates said, adding that he looks forward to getting back to work with the product groups. "I might be threatening to write code."
He more likely will be using Microsoft's development tools and doing work with developers. "It's more strategizing," Gates said.
Considering the size and status of the company, initial reaction to today's news appeared muted on Wall Street. In regular trading, Microsoft shares gained $2 to close at $107.81. The announcement that Gates is stepping aside was made after the markets had closed, but Microsoft shares did not change drastically in after-hours trading.
Although some say Ballmer has effectively been running Microsoft for some time, the change in leadership at the world's largest and arguably most powerful software company will send shock waves throughout the world. As Microsoft's co-founder and only CEO, Gates has molded the company into a feared, admired and wealthy institution known worldwide. In many ways, the company is a reflection of Gates' own steely personality.
Will the company change cultures overnight? Probably not: Although Ballmer comes across as a more gregarious type of executive, he too is known for his competitive edge. Still, change appears inevitable for Microsoft.
The company's dominance in PC software, for instance, is being challenged by other operating systems such as Linux as well as by inexpensive Internet appliances and handheld computers. Its Office software, long a market leader, now must fight for dominance in the new world of Web-hosted software offered by application service providers.
Along with these competitive challenges, the company is in the midst of a long-standing legal feud with the DOJ that so far is not going the company's way.
In addition, the battle in the computing world has turned to connectivity, and Microsoft faces a formidable foe in America Online. AOL this week announced plans to acquire Time Warner and is making a push into interactive TV, a market Microsoft has tried to invigorate with limited results.
The company has also seen defections of highly placed executives. Most recently, CFO Greg Maffei left. Despite these challenges, Microsoft has continued to churn out large profits and revenues.
Gates co-founded the Redmond, Wash.-based company with Paul Allen in 1975. Ballmer joined in 1980.
The change in top management reflects the transformation that has been sweeping through Microsoft for the last year, said Summit Strategies analyst Dwight Davis. A big part of that change, spurred by the Internet, is the arrival of software that runs on central servers instead of the desktop computers where Windows has its stronghold.
"Their change in strategy was already under way prior to the change at the top," Davis said. "The world is changing around Microsoft. (People are moving toward) hosted applications and away from deploying software on local machines. Microsoft has struggled with this internally for more than a year, knowing this transition is under way."
Sun Microsystems, one of Microsoft's fiercest rivals, has advocated this "server-centric" computing model for years. Sun CEO Scott McNealy acquired Star Division's office software, which competes with Microsoft Office, to foster this move toward server-centric software.
Gates' new title "is kind of meaningless, I think," Davis said, "but it flags the fact that Gates will be focusing much more on getting involved in product and technology decision making."
But Gates won't vanish within the software giant, Davis said. "Internally, it's going to be Steve Ballmer cracking the whips around the halls of Redmond, but in terms of an icon to associate with Microsoft, that's still going to be Bill Gates for the foreseeable future."
Last June, Microsoft's chief technology officer, Nathan Myhrvold, announced that he would take a one-year sabbatical to pursue his interests in scientific research and to travel. Some reports indicated that Ballmer forced out Myhrvold.
In July, Paul Maritz, the No. 3 executive at Microsoft, said he would give up day-to-day management responsibilities at the software maker to take a lesser role, fueling speculation that he, too, may leave.
Maffei resigned last month to become chief executive of Worldwide Fiber, a privately held firm that specializes in building fiber optic networks.
In October, Rob Bennett, director of marketing for Microsoft's consumer and commerce group, which oversees MSN, stepped down to join a digital media start-up. Also in October, a crucial architect of Microsoft's core successes during the past decade, Brad Silverberg, served his last day.
Many executives say they sought a change to rekindle the initial enthusiasm that sparked the technology revolution decades ago. Now, Gates may be one of them.
In commenting on today's announcement, Zona Research said in a report: "It may be time for a change, a back-to-the-basics refrain, or just a personal search for some of that initial thrill that the early days of software development meant."
News.com's Stephen Shankland and Scott Ard contributed to this report.