Mr Murthy, who served as Infosys chief executive from 1981 to 2002, and was the company's chairman from 2002 to 2011, has been appointed as executive chairman with immediate effect.
(Read: Who is Narayana Murthy? | Why Narayana Murthy is back to lead Infosys)
Mr Murthy will replace current chairman K V Kamath, who will become lead independent director, effective June 1. The current executive co-chairman S. Gopalakrishnan will be re-designated executive vice chairman, while current chief executive officer S.D. Shibulal will remain in his position, Infosys said in a statement on Saturday. (Read full statement)
"The Board has taken this step keeping in mind the challenges that the technology industry and the Company faces and in the interest of all stakeholders, particularly shareholders large and small, who have asked for strengthening of the executive leadership during this challenging time," Mr Kamath said.
Infosys said it will put the matter before shareholders at its annual general meeting on June 15.
Infosys slipped to the third position among India's biggest IT firms by sales earlier this week, according to a report published by global consulting firm Gartner.
"This calling was sudden, unexpected, and most unusual. But, then, Infosys is my middle child. Therefore, I have put aside my plans-in-progress and accepted this responsibility," Mr Murthy said.
(Read: Infosys shifts age limit to facilitate Murthy's re-entry)
During his five year term, Mr. Murthy would draw a token compensation of Re one per year, the company said in a statement.
Mr Murthy has requested the board to appoint his Harvard-educated son, Dr. Rohan Murthy, as his executive assistant for a five-year term. If appointed, the junior Murthy will also be paid a token compensation of Rupee one per year.
(Read: No leadership role for son Rohan, says Narayana Murthy)
Rohan, who has held fellowships at MIT, Caltech, and Microsoft Research, has authored several papers and patents as part of his research on wireless and mobile computing.
Infosys, for years an investor favourite for exceeding its earnings targets, has struggled in the past two years as its big customers in the U.S. and Europe cut costs and seen rivals such as Tata Consultancy Services and HCL Technologies take away market share.
In April, Infosys forecast full-year sales growth that missed analyst expectations by a margin of up to 50 per cent, pushing down its shares to their lowest close in a decade.
"This is a drastic, some might say, welcome move," said Ankur Rudra, sector analyst at Ambit Capital, which has a "sell" rating on the stock. "Probably, this could be a step towards a new strategic direction and leadership as well."
The company's troubles have spurred criticism of everything from its method of choosing CEOs to its pricing strategy to what is seen as an insular and risk-averse culture.
Chief executive Shibulal is one of the seven engineers who launched the company in 1981 by pooling together $250. All four CEO's so far have been from this group.
Murthy, who has earlier served on the board of HSBC and Unilever, said the calling was "sudden, unexpected and most unusual," while accepting the position.
Shares in Infosys closed 3 per cent higher on Friday, ahead of the announcement. The stock is up 4 per cent so far in 2013, compared to a nearly 7 per cent increase in the sectoral index.
(With inputs from Reuters)