McDonald, 38, has a growing reputation as a coach, after leading Melbourne Renegades to their maiden Big Bash League title this year. He has also taken Victoria to two Sheffield Shield titles, and a domestic one-day crown.
He has also held roles in the IPL, where he was Royal Challengers Bangalore's bowling coach, and in county cricket with Leicestershire.
Trevor Bayliss had previously been linked with the role after Paul Farbrace, his deputy for most of his tenure as England coach, was appointed as director of cricket, and as many as eight candidates were shortlisted, but McDonald came out on top.
Vettori has previously coached Royal Challengers, Middlesex, and Brisbane Heat with limited success, and will be assisted by Warwickshire and Worcestershire's coaches Jim Troughton and Alex Gidman.
"The Hundred is a tournament that's generating interest across the globe," said McDonald, "and the opportunity to be part of it as Head Coach of the Birmingham team is something that I'm relishing.
"From behind the scenes talking to players at the Renegades and from talk in the IPL, players around the world want to be a part of it," he said.
"The players that have a clear schedule at that time of the year want to be nominating to be a part of it. It's an exciting new format and they get to put their footprint on it."