Under the deal, LVMH - the world's number one luxury group, controlled by billionaire Bernard Arnault - agreed to relinquish most of its 23.2 per cent stake in Hermes and not to acquire any shares in its smaller rival for the next five years.
It effectively buried the possibility LVMH could make a full takeover bid for the 177-year-old maker of Birkin and Kelly handbags. Such a prospect has boosted Hermes's stock, which has been trading at price-to-earnings ratios of about 30 times in recent years, a 70 per cent premium to the industry average.
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Shares in Hermes fell nearly 10 per cent to Euro 236.5 in early trading on Wednesday, wiping out Euro 2.8 billion off its market value - equal to around 350,000 Birkin handbags based on an average price of Euro 8,000.
"The speculative premium has disappeared," said Barclays France director Franklin Pichard.
The deal, under which LVMH agreed to redistribute its stake in Hermes to its shareholders, ends four years of legal warfare between the luxury titans, dubbed the "handbag war" by the press.
In 2010, LVMH revealed it had built up a 17 per cent stake in its rival through a series of equity derivatives instead of straightforward share purchases, which prevented it from having to declaring them.
Hermes, one of France's last major independent luxury group, still controlled by its founding Hermes family, vehemently protested at having its arch-rival as its biggest external shareholder.
The French stock market regulator AMF fined LVMH last year for failing to properly disclose the stakebuilding and Hermes launched legal action against LVMH on allegations of insider trading and stock price manipulation.
LVMH fought back with proceedings against Hermes for libel.
The agreement signed on Tuesday night ended all legal proceedings between the two groups, they said in a joint statement issued on Wednesday.
LVMH, which began building up its stake in Hermes in 2007 and 2008, could made a capital gain on its holding of around Euro 3 billion, analysts estimated.
"This clears up the situation and it is one of the few divorces in which both the partners are winners," said Mario Ortelli, luxury goods analyst at Bernstein.
JP Morgan Cazenove said in a note: "LVMH has found an elegant way out of what was a deadlock." The deal marks the first time Arnault, whose LVMH has gobbled up more than 60 brands in the past two decades, including sizeable ones such as Roman jeweller Bulgari, has abandoned the pursuit of a prized target.
It was first proposed by Franck Gentin, head of Paris commercial court, in July and details were finalised rapidly over the past week, sources close to the two groups said.
Traders had long speculated LVMH was planning a full takeover bid even though the Hermes family created a shield in 2011 in the form of a holding company with 50.2 per cent of its shareholder capital. The entity received first right of refusal on shares representing another 12.6 per cent of capital and tied up many of its shareholders for two decades.
Analysts said the deal would allow for a re-rating of LVMH shares, flat since January 1, and up three per cent on Wednesday. LVMH stock has underperformed the luxury goods industry in the past 18 months over concerns about declining cognac sales in China and slower sales growth at its main profit generator Louis Vuitton.