* Combined company would be 4th largest in world
* FCA shareholders could get 5.5 billion euro payout
* Peugeot CEO Tavares would lead combined company
* Deal may be announced as early as Thursday -source (Recasts with Peugeot decision to move forward with merger talks)
By Giulio Piovaccari and Gwénaëlle Barzic
MILAN/PARIS, Oct 30 (Reuters) - The supervisory board of Peugeot maker PSA on Wednesday gave Chief Executive Carlos Tavares the go-ahead to pursue a $50 billion merger with Italy's Fiat Chrysler Automobiles NV, a source familiar with the matter said, moving the companies closer to a deal that could transform the global auto industry.
Fiat Chrysler's board and the directors of Exor NV , the holding company of Italy's Agnelli family, are expected to meet later Wednesday, people familiar with the situation said.
The two companies have yet to announce a formal agreement, and even then a deal could collapse as they dig into the details of a merger. But as of late Wednesday, the companies were progressing quickly toward an announcement as early as Thursday morning, the people said.
Spokespeople for Fiat Chrysler Automobiles (FCA) and PSA declined to comment on a timeline.
A combination of Peugeot and Fiat Chrysler would create one of the world's leading auto makers from two mid-sized players now threatened by technological and regulatory challenges.
Under the proposed deal, the companies would give shareholders cash and stakes in certain parts-making operations, the sources said.
Fiat Chrysler, with a $22.4 billion market capitalization, would pay shareholders a 5.5 billion euro special dividend, people familiar with the discussions said.
Peugeot, with a market value of 23.3 billion euros, would spin off its stake in auto parts maker Faurecia valued at around 3 billion euros.
Fiat Chrysler could dispose of its stake in factory robot maker Comau valued at about 250 million euros, these people said. Final terms of the agreement could change and have not been formally disclosed, they said.
The combined company's board of directors would have 12 members - five from Peugeot's side, five from Fiat Chrysler's, along with chief executive Carlos Tavares and as chairman, John Elkann, currently chairman of Fiat Chrysler, the people said.
Tavares was the driver of the approach to FCA, three sources familiar with the matter told Reuters. The Peugeot chief executive has moved aggressively to bulk up the French automaker. Tavares acquired General Motors Co's European units, Opel and Vauxhall, in 2017 and has led a rapid turnaround in profitability at the operations.
For Elkann, a deal with Peugeot would achieve a long-sought goal of finding a merger partner to provide sustainable scale for the company his great-grandfather and grandfather built into one of Italy's largest businesses.
Elkann had sought in May to combine Fiat Chrysler with French rival Renault. But that deal fell apart in June amid objections from the French government and tension between Renault and its Japanese partner, Nissan Motor Co.
Milan-listed shares in FCA rallied more than 10% on Wednesday, after ending up more than 7.5% on Tuesday in New York. Peugeot share rose more than 6% to hit their highest level in more than 11 years.
The merged entity would face substantial challenges. Auto manufacturers are grappling with a global downturn in demand while trying to develop costly, cleaner car models as deadlines to meet ever more stringent anti-pollution rules loom.
A combination of PSA and FCA would have to overcome a series of political, financial and governance hurdles. The future of jobs in Europe, where the companies would have overlapping brands and under-utilized factories, prompted concern among labor and political leaders on Wednesday.
Italy's industry minister, Stefano Patuanelli, said on Wednesday that Rome - which has no stake in FCA - was following talks between the two groups, but declined to comment further on a "market operation".
French government spokeswoman Sibeth Ndiaye said Paris was following the PSA-FCA talks closely with an eye on the fallout for jobs, but said an enlarged group was ultimately "the best path to protecting employment."
Rome is keen to avoid major job losses in Italy, where FCA employs 58,000 workers and with most of FCA's Italian plants heavily underused. Italian trade union FIOM said it was concerned a tie-up with PSA could hit jobs in the country even more than a Renault merger.
In Britain, unions flagged their worries for PSA plants there, which make vehicles under the Vauxhall and Opel brands.
In addition to the French government's 12% shareholding in PSA, held via state bank BPI, the Peugeot family and the Chinese government, through Dongfeng Group, each have a similar holding.
Dongfeng could use a merger deal to cash out of PSA, two sources close to the talks said. Dongfeng declined to comment. Speculation it was looking for an exit surfaced in August.
The talks come as European carmakers struggle to meet tough carbon dioxide emissions targets.
Strategy firm PA Consulting has forecast FCA faces a fine of 700 million euros ($777 million) unless it radically changes its emissions profile to sell more electric and hybrid cars.
A combination with Peugeot would give FCA access to PSA's CMP modular platform, which has already spawned the Peugeot e-208 and the Opel Corsa-e mini.
Investors have speculated for years that FCA, itself the product of an Italian-U.S. merger, was hunting for a partner, encouraged by the rhetoric of the company's late chief executive Sergio Marchionne who railed against the auto industry's "value-destroying addiction to capital" to develop often-indistinguishable products.
Lazard is advising Exor, Goldman Sachs is advising FCA, and Mediobanca is advising PSA through its Messier Maris & Associés unit, sources said.
($1 = 0.9000 euros)
(Reporting by Giulio Piovaccari and Gwenaelle Barzic Additional reporting by Gianluca Semeraro, Stephen Jewkes and Silvia Aloisi in Milan, Sudip Kar-Gupta in Gdansk, Sarah White in Paris, Josh Franklin in New York and Pamela Barbaglia in London; Editing by Mark Potter and Leslie Adler)