The programmed integration, with financial support from the Gulf emirate of Qatar, provoked the departure of Porsche chief Wendelin Wiedeking, said to be Germany's highest paid boss.
Porsche's supervisory board, rocked by an epic boardroom battle that fuelled a caustic family feud, reached agreement following all-night talks on a plan to merge Porsche and VW that seemed to leave the latter in the driver's seat. Porsche currently owns 51 percent of the much bigger VW.
"We have opened the way ... to the creation of an integrated group," VW chief executive Martin Winterkorn said following a meeting of his group's supervisory board in the southwestern German city of Stuttgart where Porsche is based.
Winterkorn is tipped to lead what could be the second biggest global auto maker behind Toyota of Japan, given the undetermined extent of US giant General Motors' collapse.
A project approved by both Porsche and VW would see Porsche completely integrated into VW, but reinforce the former's finances to guarantee it a minimum of independence. In practice, the VW group is to progressively buy Porsche's auto-production unit, making it VW's 10th brand alongside divisions like Audi, Seat, Skoda, Scania or Lamborghini.
The holding companies Porsche SE and Volkswagen AG would also merge. Within that context, Qatar would acquire around 17 percent of VW, Winterkorn said. But Qatar could also invest directly in Porsche, a move approved by that company's supervisory board at the same time it decided on a capital increase of at least €5 billion ($7 billion).
That should allow Porsche to "negotiate (a merger) with VW on equal terms," supervisory board president Wolfgang Porsche told around 5,000 of the company's workers in a trembling voice.
The plan, final details of which are to be presented on August 13 following a meeting of the VW board, seals the failure of a gamble by Wiedeking and Porsche's management to take over VW. That strategy, one of the most spectacular corporate operations in German
history, almost succeeded.
Stuttgart-based Porsche tried to acquire 75 percent of the shares in VW but had to abandon the attempt in May against a background of slumping auto markets and tighter credit conditions.
Wiedeking and Porsche finance director Holger Härter resigned on Thursday and were to receive severance pay of €50 million and €12.5 million respectively.
Wiedeking, who is believed to have earned around €80 million last year, said he would give half of his payoff to charities, including €1.5 million to "journalists in need." He had come under sustained attack, in part through press reports that did not identify their sources, amid a furious months-long clan war between the Porsche and Piech families, which own the Porsche holding company.
Wiedeking was the principle target of Ferdinand Piech, grandson of Porsche founder Ferdinand Porsche, who invented the VW Beetle.
Piech is also president of the VW supervisory board and appeared to be the main victor in a struggle for control over both carmakers. Nicknamed "the patriarch" by German media, Piech is now well placed to pursue his dream of creating an auto group able to overtake Toyota and become the biggest in the world.
That target was confirmed once more on Thursday by Christian Wulff, regional premier of the German state of Lower Saxony, where VW is based and which owns 20 percent of the auto manufacturer.