Under the terms of the settlement, Sir Peter will now receive a cash payment of £2.6m and a final settlement of his claim for shares under the 2003/04 and 2004/05 restricted share plans.
He will continue to receive payments in respect of salary at the reduced rate of £500,000 per annum.
This represents a reduction by Sir Peter of approximately £1m from his contractual entitlement.
The retailer has been under pressure from city investors who viewed the pay-off as “a reward for failure”.
Meanwhile Sainsbury has also announced that Lord Levene of Portsoken and Keith Butler-Wheelhouse have resigned as non-executive directors.