The collaborative development strategy will see Nokia adopt Windows Phone as its principal smartphone platform, eventually ceasing the development of its own Symbian and MeeGo systems.
"Nokia and Microsoft will combine our strengths to deliver an ecosystem with unrivalled global reach and scale. It's now a three-horse race," said Nokia president and CEO Stephen Elop at a joint news conference in London.
In the mobile industry, an ecosystem is the association of both hardware (Nokia) and software developers, as well as application makers, e-commerce, multimedia services, advertising and social applications.
This means that Nokia and Microsoft will combine all their services and apps, including Microsoft's search engine Bing, in the launch of their new phones, which investors are not expecting before next year.
Investors, however, are seemingly unimpressed with the news, as Nokia's shares were down more than 13% on Friday to $9.4 as of 12:45pm EST. This is reportedly to do with Elop saying there are "significant uncertainties" over how the partnership with Microsoft will affect the Finnish company's financial results.
According to reports, Elop also said that there would be "substantial reductions in employment" accross various parts of the world, and that Nokia will be reducing its research and development budget.
Nokia once dominated the smartphone market, but has suffered in the face of tough competition from Apple's Iphones and Google's Android. Nokia's market share in the fourth quarter dropped from 38.6% in 2009 to 28% in 2010, according to research firm International Data Corporation.