O'Neill, who takes charge of the side for the first time against Norway on Wednesday night, had initially said he would not appoint a permanent skipper until the World Cup qualifying campaign started in September, but has chosen to give the armband to midfielder Davis.
Fulham defender Hughes captained the side for eight years before announcing his retirement last year, but despite having reversed that decision at O'Neill's prompting, he will now be back in the ranks and playing under the Rangers captain.
"Steven Davis is the captain and he will be the captain going forward," said the former Shamrock Rovers boss.
"I just thought at this stage of his career and with a new manager coming in it was maybe time and it would benefit the squad. I had a long chat with Aaron about the situation and he was, as you'd expect, totally supportive and understanding.
"He didn't have any expectation to come back as captain having made his decision (to retire) towards the end of the last campaign, he was very supportive of Steven and very supportive of the decision."
Davis, who captained the side against Estonia when injury denied Hughes what was supposed to have been a farewell appearance, did not expect to get the nod. Having played so long under Hughes' leadership, he fully expected to do so again once the centre-back was tempted back into the national set-up.
"I just thought Hughesy would come in and get it automatically again, and I had no qualms with that," he said.
"But the manager has decided to go with me and I'm delighted. I'm very proud. Growing up, even getting the opportunity to play for your country is a big thing so to lead the team out and wear the armband is massive. I'm honoured to get the chance to do it."
Derby forward Jamie Ward is unlikely to feature tomorrow night having suffered from a tight thigh muscle in training, leaving 21 players for O'Neill to choose from following the withdrawals of Craig Cathcart (hamstring) and Warren Feeney (calf).
Source: PA
Source: PA