Nadella is Microsoft's third CEO in its 39-year history.
The Redmond, Wash.-based software giant also replaced Chairman Bill Gates with John Thompson, the company's lead independent director. Gates remains on the board and assumes the title of "founder and technology advisor."
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"During this time of transformation, there is no better person to lead Microsoft than Satya Nadella," said Gates in prepared remarks.
Microsoft shares were up 0.3%, to $36.58, in early trading.
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Veteran executive Nadella, who has been with the software giant for more than two decades, is a rising star within Microsoft's ranks. He's been been running its enterprise and cloud divisions, business units that have performed favorably.
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"He's a very talented, technical leader," says Zynga CEO Don Mattrick, who ran Microsoft's Xbox division until July. "It will be interesting to see what he does. It's a transition for Microsoft, in what it intends to do for its growth agenda."
The selection of Nadella to take over comes as the company's path is uncertain. Since Ballmer took the helm 13 years ago, a lot has changed in how people use computing. That has shifted the balance against Microsoft in mobile and Internet businesses in particular.
"The opportunity ahead for Microsoft is vast, but to seize it, we must focus clearly, move faster and continue to transform. A big part of my job is to accelerate our ability to bring innovative products to our customers more quickly," said Nadella in a statement.
Microsoft relevance has long been waning. Saddled with a legacy of ho-hum business computing software, the software behemoth has been slow to move on exciting consumer products.
"Ballmer's biggest failure is his lack of vision.! He showed a lot of fear and derision of any new, emerging product categories. That fear rubs on an organization," says Mark Rolston, founder of argodesign.
Ballmer had become the perennial whipping boy of the tech world for milking its legacy Windows operating system amid struggles to adapt to the Internet, mobile and cloud computing booms.
As a result, a series of missteps over the past decade have revealed Microsoft lacking a visionary leader capable of big bets on the next computing revolution, a void expected to be filled by its new chief.
Ballmer may have blown it one too many times. The launch of Windows 8 was troubled to say the least. Ditto for its mobile versions and lack of market traction for its software powering smartphones and tablets.
Things also took a turn for the worse for Ballmer when activist investor Jeff Ubben took a stake in Microsoft in April and began exerting pressure on the company to change.
Maybe the task of software soothsayer was just too much. By August, Ballmer announced he was planning to step down following a search for his successor. He told The Wall Street Journal at the time that he couldn't change Microsoft quickly enough. "Maybe I'm an emblem of an old era, and I have to move on," the 57-year-old Ballmer told the paper as his eyes reportedly welled up.
Contributing: Alistair Barr and Jon Swartz
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