Davies was considered to be among the leading contenders for the position when the Blues announced last month that they were seeking a rugby director to work above coaches Gareth Baber and Justin Burnell.
Davies, 48, has spent the last two seasons working as forwards coach at Worcester, helping them secure promotion to the Premiership last term, and had two years left on his contract at Sixways.
But he is free to return to his homeland after a compensation deal was agreed between the two sides.
Davies will effectively fill the shoes of Dai Young at the Blues, as the region have been without a rugby director since Young's departure to Wasps last summer.
Cardiff Blues chief executive Richard Holland said: "Phil Davies is a hugely respected coach and we are delighted to have secured him as the new Cardiff Blues Director of Rugby.
"He has shown during his time at the Leeds Tykes, when he took them from Division Three to the Premiership, that he can develop a young team and deliver success.
"He is hugely knowledgeable about the game, extremely hard working and we look forward to having him with us for the forthcoming season."
Davies, who won 46 caps for Wales as a lock and back-rower during his playing career, added: "I'm really looking forward to starting the job. It's a role I've been passionate about for a long, long time.
"The Blues cover a massive region, the biggest in Wales, and it's a great opportunity for a young group of players and staff to work hard in order to push the region forward and look to build upon the foundations that have been laid over the last eight or nine years, firstly by David Young and more recently, Gareth and Justin.
"Our aim will be to move forward, play attractive rugby and over time develop the Blues into a very competitive side in all competitions and ultimately win trophies and produce quality players to represent Wales."
Davies spent 10 years with Leeds between 1996 and 2006, taking them to the Premiership and a Powergen Cup triumph during his tenure.
He left to join the Scarlets and guided them to the Heineken Cup semi-finals in 2007 before leaving a year later after a difficult second season.
He also worked for the Welsh Rugby Union as Wales Under-20s boss and national academy manager before moving to Worcester.
The role will provide Davies with a major test with the Blues losing the likes of Gethin Jenkins, Casey Laulala, Dan Parks and Rhys Thomas at the end of the season as the Welsh regions continue to feel the financial pinch ahead of the introduction of next season's salary cap.
Worcester have wished their departing coach well as he prepares for his final game with the club against Northampton on Saturday, with managing director Charlie Little saying: "Phil is a proud Welshman and we realise this is a big opportunity for him.
"We have reached amicably terms of release with Cardiff Blues and we wish him well and thank him for everything he has done for the Warriors."
Gilbert has released a new line of rugby cleats. The Gilbert Virtuo 8S is part of the exciting new product. Check it out.
The entire All Blacks apparel line has been updated for 2013/14. Check out the New Zealand All Blacks polo.
The Nike Tiempo is a solid rugby cleat and one of few styles still made from full-grain natural leather.
The Gilbert Blitz 8S rugby cleat is a great cleat at a great price of $69.99. Get a new pair of cleats today.
A cool looking all black rugby cleat with the high performance adidas is known for. Get in the Gear!
Wear the crest of the British and Irish Lions on your t-shirt. A great look for the summer.
The All Blacks Performance t-shirt is black with hints of blue from the training jersey. Very Cool.
The New Zealand All Blacks training jersey for 2013/14. Get in the Gear!
The USA Rugby Pro Alternate rugby jersey is perfect for any fan of the Eagles. Get yours to wear during the summer Test matches.
The NEW All Blacks 2013/14 jersey has arrived at World Rugby Shop. Dare to wear the colors of the All Blacks.