Ted Baillieu has resigned as Premier after a Liberals-only crisis meeting on Wednesday night, saying "I do this in the best of the government".
Denis Napthine is the new leader and Mr Baillieu will remain in parliament.
"I love this state, I love the Liberal Party and I love this role that I have had the honour to enjoy over the last two and a bit years," Mr Baillieu told reporters.
"It is apparent to me that a change of leadership is in the best interests of the government."
"I want to thank the people of Victoria.
"I wish Denis Napthine the best. He has my full support. He's an outstanding individual.
Mr Baillieu said he will shortly visit the governor to tender his resignation.
He thanked his family and said the most important thing is the people of Victoria.
Dr Napthine is about to hold his own press conference.
Earlier, Frankston MP Geoff Shaw quit the Liberal Party because he no longer had confidence in Premier Ted Baillieu.
In a scathing statement issued this evening, Mr Shaw said the state government had not made enough progress."Labor left Victoria in a mess and Victorian's elected a Coalition Government to fix the problems and build for the future. While the government has made significant progress in that direction, I believe my actions reflect the general loss of confidence Victorians are feeling in the leadership of the government."Mr Shaw said: "This morning I advised the Premier of Victoria of my resignation from the Parliamentary Liberal Party, effective immediately.As always my focus is on how I can best represent the people of Frankston and at the moment I believe that is from the cross bench."
As Mr Shaw left state parliament just before 7pm, he told the media to have a good dinner, and then added: "It will all come out soon".
Ted Baillieu has declared the Coalition will continue to govern decisively despite losing its majority in Parliament following Mr Shaw's shock resignation from the Parliamentary Liberal Party.
Mr Baillieu this afternoon emerged from a party room meeting claiming to be "very confident" that the Parliament was workable. Mr Baillieu made the claim despite admitting he had not spoken to Mr Shaw, or Victorian Governor Alex Chernov.
"We are committed, we have a very strong forthcoming agenda and we have been able to govern with a narrow margin and I believe we can continue to govern and we will govern with decisiveness and with courage," Mr Baillieu said.
Asked if Mr Shaw had indicated whether he would support the Government in with his vote in Parliament, Mr Baillieu said: "He has spoken to a number of people and he has indicated ... he will be considering his position.
Deputy Premier and Nationals Leader Peter Ryan said he had complete confidence Mr Baillieu would continue to lead with himself as deputy, denying the party was in crisis.
Although Mr Shaw did not make an appearance in the lower house today and has made no formal announcement, he has been seen dining with Coalition MPs in the private parliament cafe.
Mr Shaw's resignation has potentially huge ramifications for an under-pressure Baillieu government, which holds power with a one-seat majority.
The beleagured MP is expected to remain in the lower house as an independent.
Government MPs were called into Premier Ted Baillieu's office on Wednesday morning.
Several ministers walking into the Premier’s office appeared worried. Matthew Guy, Michael O’Brien, Kim Wells and Robert Clark were among them.
Police said on Wednesday that they were still investigating allegations of misconduct in public office by the Frankston MP and "as the investigation is ongoing, it would be inappropriate to comment further".
The Liberal-National coalition holds 45 seats in the 88-seat lower house and the ALP, 43.
Mr Shaw's resignation leaves the Coalition with 44 seats, the ALP with 43. The Frankston MP will hold the remaining seat on the cross-bench.
Mr Davis has told the upper house he is not aware if there had been discussions with Mr Shaw about whether he will guarantee supply - effectively the passage of money-related leglislation.
If Mr Shaw does not guarantee supply, parliament will not be workable for the Coalition.
Mr Shaw won his seat – Frankston North – by 51.7 per cent to 48.3 per cent on a two-party-preferred basis in 2010. He won the seat from the ALP with a 4.4 per cent swing.
The government's majority will be protected for the next two months, as the next member for the safe Labor seat of Lyndhurst will not be elected until May 18, replacing former minister Tim Holding, who has already left parliament.
A Liberal source said speculation that the move by Mr Shaw was due to changes to electoral boundaries was "just nonsense".
Opposition leader Daniel Andrews weighed in, saying the government was "in absolute crisis".
Mr Shaw has weathered controversy many times in his short parliamentary career.
The 45-year-old – a qualified financial planner and accountant – won the lower-house seat of Frankston in 2010 from ALP incumbent Alistair Harkness.
Besides being an MP, Mr Shaw runs two small businesses: an accounting firm and a hardware factory. In May 2012, it was alleged his staff, as well as Mr Shaw himself, had used his parliamentary car for business related to the hardware factory.
In December 2012, Victoria Police announced a criminal investigation the affair, investigating Mr Shaw for misconduct of public office for rorting his taxpayer-funded car and parliamentary fuel card.
A week later, the Gillard government launched a review into Mr Shaw over allegations he illegally or dishonestly accessed federal assistance for his private businesses. Mr Shaw received individual payments of up to $1500 each from the Commonwealth to hire three long-term unemployed workers for his hardware firm under an employment assistance scheme.
There have been many other controversial moments. In April 2011, he offended a young gay man in his constituency by suggesting that his desire to love who he wanted was as illegitimate as a dangerous driver wanting to speed or a child molester wanting to molest. In the days that followed, Mr Baillieu said it was wrong for Mr Shaw to have made the comparisons that he made.
In June 2011, Mr Shaw admitted he had been charged with assault in 1992 while working as a nightclub bouncer. He was fined and placed on a good behaviour bond for the assault but there was no conviction.
In August 2011, Mr Shaw got into a roadside fight in his electorate, involving himself in a conversation between a police officer and a 21-year-old driver. The driver and Mr Shaw – a black belt in karate – got into a fistfight.
His personal life has been unsettled as well. Mr Shaw separated from his wife Sally in 2011. In April of that year, police were called to the former family home when Shaw refused to leave the house.
In April 2012, Shaw erected a banner on Golf Links Road in Frankston South pleading for forgiveness from his ex-wife.
There will be a full Coalition party meeting at 1pm to discuss Geoff Shaw.
The latest development comes amid mounting speculation about Mr Baillieu's leadership.
Liberal backbencher Bill Tilley said while he believed Mr Baillieu was listening, the government’s leadership team needed to revamp the way it dealt with the backbench.
‘‘It’s a management thing,’’ Mr Tilley said.
‘‘There should be some further and significant conversations: how to interact with the executive and the backbenchers to deliver the right, the proper and accurate messages to Victoria.’’
Mr Tilley is annoyed with Mr Baillieu over comments he made about him in parliament on Tuesday.
Mr Baillieu told parliament Mr Tilley quit his role as parliamentary secretary to Police Minister Peter Ryan because his conduct was inconsistent with the role.