Butcher, 54, arrives from Hibs' top-flight rivals Inverness Caledonian Thistle and will be joined at the Edinburgh club by his assistant Maurice Malpas.
"I'm excited about the future and what we can achieve at Hibernian -- it's a great honour to be appointed the new manager of the club," Butcher told the club website.
"I've been really impressed with the set-up; from the training facilities through to the stadium, everything is in place and now our goal is to deliver the success on the pitch that everybody wants."
Inverness climbed to second place in the table by winning 2-0 at Hibernian on Sunday, leaving Butcher's new club in seventh place after a run of four consecutive defeats.
Butcher's first match will be against St. Mirren on 23 November.
"Terry is vastly experienced in Scottish football and an outstanding leader of men," said Hibs chairman Rod Petrie.
"He inherits a talented squad of players and we believe he has got the managerial skills and motivational qualities required to develop them as players and as a team and move the club forward."
Butcher made 77 appearances for England and scored three goals during a ten-year international career that saw him play at three FIFA World Cups™.
He has previously managed Coventry City, Sunderland, Motherwell, Brentford and Australian A-League outfit Sydney FC.