They rejected an approach from Everton for Silva - an action that they claimed had an unsettling influence on their manager, pre-empting the hard run of form that they have not been able to lift themselves from.
Although Watford is midtable with 26 points from 24 matches, it is only four points above the relegation zone.
The Hornets board said Everton's approach for Silva in November was the "catalyst" for their decision but the attention now turns to Gracia.
"Watford Football Club has parted company with Marco Silva", read a statement released by the Hornets.
The statement added: "This has been a hard decision and one not taken lightly".
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Reports in the British media had claimed that Everton FC had targeted Silva in their quest to replace Dutchman, Ronald Koeman.
"I think Watford have got enough within the club to be safe, but that's not to say they don't need more direction".
Of particular concern to the club was the number of games surrendered from winning positions, particularly the two late goals they conceded to lose 2-1 at home to Swansea on December 30, having led since the 11th minute when Andre Carrillo scored the opener.
The 47-year-old Spaniard, who has been out of work since leaving Rubin Kazan in Russian Federation in June, made a name for himself in the dugout in his homeland with Malaga.
BC-SOC-Watford-Coaching Change, 2nd Ld-Writethru, 258 Watford's 9th coaching change in 6 years as Gracia is hiredAP Photo LON110Eds: Updates throughout with details, quotes.
But Watford stood firm and blocked the approach from the Merseysiders despite Silva's desire to open negotiations with the Toffees, and were keen to keep Silva to his two-year contract that still had 18 months left to run.