Dyche steps up to the top job from his previous role as assistant to Malky Mackay, who left to take over at Cardiff last week.
The 39-year-old former defender had spells playing for Chesterfield, Bristol City, Millwall, Watford and Northampton.
Owner Laurence Bassini said: "I'm delighted that the Board - Graham Taylor, Stuart Timperley and David Fransen - have been able to add their experience and influence to the decision to appoint Sean as our new manager."
Chairman Graham Taylor said of Dyche's appointment: "On behalf of the Board, I fully endorse Sean's appointment. It is very good news for Watford Football Club.
"Continuity is imperative. In Sean, we have a very decent man who understands what it means to work for Watford.
"He is a strong advocate of the importance of our home-grown talent flourishing, having been youth-team coach only a couple of years ago," added Taylor.
"For me, this appointment is very much in keeping with 'The Watford Way' of doing things - and that's an ethos I'm growing more familiar with as time goes on," explained Bassini.
"It's important we've appointed someone who has a real feeling for what this club is about. I'm very glad we've been able to reach this point now
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