Birmingham Prison is to become the first jail in the UK to be privatised, Justice Secretary Ken Clarke has said.
The decision to award security firm G4S the contract to run the 1,400-inmate jail came after firms competed over the running of four prisons in England.
The Prison Officers' Association called the decision "disgraceful" and has not ruled out taking industrial action.
Mr Clarke told MPs the "military are involved" in contingency plans should prison officers stage a strike.
Thirteen private prisons already exist in the UK - 11 in England in Wales, and two in Scotland - but this is the first existing public sector prison to be contracted out.
Mr Clarke has said the move will save money and improve performance on issues such as cutting reoffending rates.
Hundreds of prison officers held a meeting outside Birmingham Prison minutes after the announcement was made. The union told its staff to turn up as normal on Friday, when a branch meeting will be held.
Although prison officers are banned from going on strike, the strength of feeling is such that some kind of spontaneous action is a "distinct possibility", said BBC Home Affairs correspondent Danny Shaw.
The Prison Reform Trust said there was a question mark over whether increasing privatisation was a "good way" of improving the system.
Home affairs correspondent, BBC News
The private sector has operated newly-built prisons for almost 20 years.
Indeed, Ken Clarke, who was responsible for the Birmingham decision, became home secretary in April 1992, just days after Britain's first ever private jail opened - the Wolds, in East Yorkshire.
Across the UK, 12 other jails are now privately-managed - but none was previously in the public sector.
It's this - the transfer of a publicly-run jail into a private one - that's so angered the unions.
Not only are they worried that it'll bring job cuts and a reduction in union membership, they're concerned the privatisation bandwagon will roll on.
Although prison officers are banned from going on strike, the strength of feeling is such that some kind of spontaneous action is a distinct possibility.
The last time did that, in a pay dispute in 2007, 20,000 members walked out.
In his announcement Mr Clarke also told MPs that G4S would run the proposed Featherstone 2 prison, a new jail opening near Wolverhampton, while Serco would continue to run Doncaster Prison, which was built by a private company.
Doncaster will become the first prison to be run on a "payment by results" basis, with Serco getting its full payment only if reoffending rates were reduced, Mr Clarke told the Commons.
The other prison in the competition, Buckley Hall, in Rochdale, will continue to be run by HM Prison Service, he said.
The competition between public and private bidders to run the prisons was launched by the last Labour government, in 2009.
Birmingham jail's 752 staff were told the result of the tender at noon, BBC home affairs correspondent Danny Shaw said.
He said the Prison Officers' Association (POA) had a long-standing mandate from its members to take industrial action if any prisons were contracted out to the private sector.
In a statement, Steve Gillan, general secretary of the POA, said: "This is a disgraceful decision. Prisons should not be run for the benefit of shareholders nor for profit.
"The state has a duty to those imprisoned by the criminal justice system and this coalition government have betrayed loyal public sector workers for their friends in the private sector."
He later added: "We will not make a knee-jerk reaction. We will study what we can do and take direction from our members, but we will not rule out industrial action."
The Birmingham prison officers returned to the jail following their impromptu meeting but were said to be feeling "bitter" about the announcement.
Mr Gillan said they had been working for the past two years in an atmosphere of uncertainty and added that there was "understandably a feeling of disquiet".
In his statement Mr Clarke also said Wellingborough Prison, in Northamptonshire, had been withdrawn from the competition and would need to deliver the 10% efficiency savings required by all prisons over the next four years.
Prison Reform Trust
He said the changes would bring savings of £21m for the three existing prisons and deliver the new Feathersone 2 prison £31m cheaper than originally planned and said "cumulative savings over the lifetime of the contracts for the three existing prisons are very impressive at £216m".
Mr Clarke said: "This process shows that competition can deliver innovation, efficiency and better value for money for the taxpayer - but also that it can do so without compromising standards.
"Public protection is not just about how we manage prisons in order to punish people. It is also about how we achieve genuine and long-lasting reductions in crime, by cutting reoffending."
Mr Clarke said that central to this was the pilot payment-by-results project at Doncaster Prison, where 10% of the contract price will be held back unless the prison can cut by 5% or more the one-year reoffending rates.
Doncaster's operator Serco will work with a range of voluntary sector and other organisations to "enable them to meet the specific needs of each individual offender".
Juliet Lyon, of the Prison Reform Trust, pointed out that the UK had a higher proportion of prisoners in private hands than the US.
She added: "It's a very large proportion of people to be held in that way, given that prison is our most extreme form of punishment.
"We must make sure that there's adequate monitoring, proper checks and balances, to make sure this is done on behalf of the state and done properly.
"The real concern is about very poor reoffending rates and that's got to be improved. The question remains is it a good way of doing it to try and introduce more privatisation? Will that improve performance and accountability or will it lead to such tensions in the system that standards could in fact fall further?" she added.
The new contracts come into force from October, except Featherstone 2, which runs from April 2012.
all this adds up to more privatisation under the tories who seem driven by it. Whether they have the private sector breathing down their neck for government contracts or not this is no way to go i feel. Firstly it is disgraceful that prison officers are not allowed to go on strike. In the article it suggests they are talking amoungst themselves as to what todo but they and teh wider public must resist these moves. Lets say no to privatisation by the tories. Our prison officers do a excellent job in this country under some very tough circumstances they are faced with unruely prisoners on a daily basis and should be commended in their efforts. THis is no way to treat them by threatening to privatise their jobs and sell them off to the private sector to make anotehr quick buck out of them. I strongly oppose this move and hope others will join me in saying no to privatisation to this sector of workers.