The creation of the new company, dubbed Air France-KLM, would form an aviation giant with annual revenues of about $22 billion.
The deal would mark the first time two major European airlines had joined forces in such a tight alliance. KLM's board unanimously approved the deal, the airlines said.
"We have always been convinced of the necessity of consolidation in the airline industry. Today, we announce a combination with KLM that will create the first European airline group," Jean-Cyril Spinetta, Air France CEO said in a statement.
Under the terms of the deal, the French government's 54.4 percent stake in Air France would be diluted to 44 percent, the statement said,
The group would serve 226 destinations worldwide, Air France said, operating a fleet of 540 aircraft and employing about 106,000 people. The group will maintain two operating companies.
The two companies expect to sign the transaction agreement in the next few weeks.
The union, the first between major European carriers, comes as many airlines are seeking to survive a downturn in travel that followed the Sept. 11, 2001, terror attacks. Major airlines have also suffered because of wars in Afghanistan and Iraq, outbreaks of severe acute respiratory syndrome and tough competition by no-frills rivals like Ryanair and easyJet.
The statement said that the combined group could be "reinforced by the potential integration of Alitalia," Italy's flagship carrier.
Alitalia has said it would like to join a three-way alliance with KLM to help it increase productivity and remain competitive in a global market.
By Jamey Keaten