Before his retirement, the 57-year-old will continue to oversee the company’s new "one strategy, one Microsoft" reorganisation of the company it announced last month, as it seeks to "innovate with greater speed, efficiency and capability".
Ballmer, known for his distinctive leadership style (see below), said: "There is never a perfect time for this type of transition, but now is the right time
"We have embarked on a new strategy with a new organisation and we have an amazing senior leadership team. My original thoughts on timing would have had my retirement happen in the middle of our company’s transformation to a devices and services company. We need a CEO who will be here longer term for this new direction."
A special committee comprising John Thompson, an independent director on the Microsoft board, chairman of the board and Microsoft founder Bill Gates, chairman of the audit committee Chuck Noski and chairman of the compensation committee Steve Luczo will choose a successor.
Gates said: "As a member of the succession planning committee, I’ll work closely with the other members of the board to identify a great new CEO.
"We’re fortunate to have Steve in his role until the new CEO assumes these duties."
Ballmer assumed the chief executive role in 2000 as successor to Gates and was responsible for financial decisions, while Gates remained on as chief software architect until 2006.
In recent years, Microsoft has drawn criticism for not innovating fast enough in the face of competition from Google and Apple.
Microsoft is now attempting to gain ground on Google and Apple in the mobile space with the launch of its tablet Surface computer and its Windows Phone operating system.