The announcement comes just 24 hours after the Scot returned from a meeting with principal owner John Henry and chairman Tom Werner in the USA.
Dalglish paid the price for failing to close the gap on the Premier League top four, with the Reds finishing eighth despite significant investment in playing staff in his 17 months in charge.
"After a careful and deliberative review of the season the club came to the decision that a change was appropriate. It is not a decision that was reached lightly or hastily. The search for a new manager will begin immediately."
Werner said they had made a tough decision to remove a man who is held in such high esteem at Anfield following his exploits as a player and manager in his previous spell in charge.
He acknowledged the effect the 61-year-old had produced in putting things on a more even keel after a disastrous six months under Roy Hodgson, but felt a change was required.
"Kenny came into the club as manager at our request at a time when Liverpool Football Club really needed him," he said. "He didn't ask to be manager; he was asked to assume the role. He did so because he knew the club needed him.
"He did more than anyone else to stabilise Liverpool over the past year-and-a-half and to get us once again looking forward. We owe him a great debt of gratitude.
"However, results in the Premier League have been disappointing and we believe to build on the progress that has already been made, we need to make a change.
"We are committed to delivering success for our supporters and our ambition remains resolute to return this great club to the elite of England and Europe, where it belongs."
'Heart and soul' of Liverpool
Henry was also fulsome in his praise for the Scot. "Kenny will always be more than a championship-winning manager, more than a championship-winning star player," he said.
"He is in many ways the heart and soul of the club. He personifies everything that is good about Liverpool Football Club. He has always put the club and its supporters first. Kenny will always be a part of the family at Anfield.
"Our job now is to identify and recruit the right person to take this club forward and build on the strong foundations put in place during the last 18 months."
Despite winning the Carling Cup and reaching the final of the FA Cup, the Reds' league results were disappointing. A 14th defeat of the season at Swansea City on the final day condemned the club to their worst league finish for 18 years and their lowest points tally, 52, since 1953/54.
Prior to the start of the season Henry had suggested that UEFA Champions League qualification was the minimum requirement. There had been progress made under Dalglish, who initially took temporary charge in January 2011 with the club dangerously close to the foot of the table after Hodgson failed badly.
The Scot was given a three-year contract a year ago but an inability to sufficiently close the gap to the top four despite a significant outlay on transfers appears to have persuaded Fenway Sports Group a change was required.