Kadima's recently-elected leader, Shaul Mofaz, is set to be named deputy PM.
Mr Netanyahu said their new coalition wanted a "responsible" peace process with the Palestinians and "serious" talks about Iran's nuclear programme.
The move came as parliament debated its dissolution before an election Mr Netanyahu had planned for September.
Kadima is currently the biggest party in the Knesset, but recent polls have suggested the number of seats it holds could be halved.
The coalition will have a majority of 94 - one of the biggest in Israeli history.
President Shimon Peres said the deal was "good for the people of Israel".
'Move of unity'
At a news conference with Mr Mofaz on Tuesday, Mr Netanyahu said he had "jumped at the chance" to create Israel's "broadest government".