The deal, which the companies hope to close by the end of 2010, ends the British flag carrier's long pursuit of Iberia to create an enlarged group, able to cope with the industry's largest downturn in decades.
BA shareholders will have 55 percent of the combined firm, to be headquartered in London with 419 aircraft flying to 205 destinations, while Iberia shareholders are to get 45 percent.
In a joint statement, BA and Iberia said the merger would provide enhanced scale to compete with other major airlines and participate in future industry consolidation.
The new company will combine British Airways' strong position in Europe-to-North America traffic with Iberia's Latin American business, and will potentially be reinforced by a planned alliance with AMR Corp's
Iberia's chairman Antonio Vazquez will be chairman of the new company, while BA's Chief Executive Willie Walsh will be CEO. Each airline will have seven members on the new 14-member board.
The deal will create a new holding company, which will own the two airlines. The two companies will have dual hubs in London and Madrid, and will keep their own licenses, codes and brands for the first five years of the merger.
This mirrors the structure set up by Air France-KLM
Ahead of the announcement of a deal, BA shares closed 7.5 percent higher at 206.8 pence, while Iberia shares ended up 11.8 percent at 2.22 euros.