The 46-year-old guided Doncaster to promotion from the Conference in 2003 and then won the League Two title the following season, and has also managed Darlington and Oldham.
Penney told the club's official website, www.bristolrovers.co.uk.: "I made a conscious decision when I came out of Oldham I was going to try to choose the right football club, and I have been in the fortunate position that I could wait a bit. This felt right when I had the interview.
"It is an exciting time for myself and something for me to get my teeth into. When you can get this club going in the right direction the fans get right behind the team.
"There is half a season left and plenty of time to turn the season round, get the players back at it and add a couple of additions in the next month to make us stronger. Every game is winnable if you go in with the right attitude. We have got to go into games with that frame of mind. First and foremost we need to make sure we are in this division next season."
Penney replaces Paul Trollope, who was sacked in December. Rovers are currently third from bottom in League One.