Liverpool FC and Fenway Sports Group (FSG) have confirmed that "Kenny Dalglish is to leave his post today as manager after having his contract terminated".
"After a careful and deliberative review of the season, the club came to the decision that a change was appropriate," said a statement on the Liverpool website.
"It is not a decision that was reached lightly or hastily."
The club said the search for a new manager will begin immediately.
FSG and Liverpool owner John Henry paid tribute to Dalglish, who he described as "the heart and soul of the club".
"Kenny will always be more than a championship winning manager, more than a championship winning star player," Henry said
"He personifies everything that is good about Liverpool Football Club.
"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."
Liverpool Chairman Tom Werner said it was a tough decision, but ultimately one that needed to be made.
Werner thanks Dalglish for stabilizing the club but said "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".
Dalglish said he was "disappointed" to be leaving, but commended the owners in how the exit had been handled.
"I would like to thank all of the staff at the club for their effort and loyalty," he said.
"I said when first approached about coming back as manager that I would always be of help if I can at any time and that offer remains the same.
"Finally, I want to put on record my heartfelt gratitude to Liverpool's fans, who have always given me and the club their unwavering support.
"Without them neither the club nor I would have achieved anything."
Dalglish's departure brings to an end his second spell at the Club where, as a player, he won numerous honours, including six English league titles and three European Cup trophies. As manager he won three league titles, two FA Cups and this season's Carling Cup.
Despite the Carling win, and reaching the final of the FA Cup the Reds' league form was disappointing this year.
A 14th defeat of the season at Swansea on the final day of the season condemned the club to an eighth-place finish, their worst for 18 years and their lowest points tally (52) since 1953/54.
Prior to the start of the season Henry had suggested that 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 a disastrous six months under Roy Hodgson.
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 FSG a change is required.