The deal was signed in Rome between Etihad CEO James Hogan and his Alitalia counterpart, Gabriele Del Torchio.
Shareholders also agreed to a €300 capital increase to keep the airline afloat until the deal is fully in force, La Repubblica reported.
Etihad's will initially invest €560 million, while €660 million has been earmakred for the future.
"We made it, after so much effort, so many nights and a year of work," Del Torchio was quoted in La Repubblica as saying.
Hogan said he was happy to invest in Alitalia and make it stronger.
“Having Alitalia as a partner is crucial for us,” he added.