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.
It means Aaron Hughes, who led the side for eight years, must go back into the ranks following his retirement U-turn, but O’Neill believes now is the right time for a change.
He also feels midfield lynchpin Davis will benefit from the morale boost following a difficult few weeks at Rangers, who are under intense daily scrutiny following their slide into administration.
“Steven Davis is the captain and he will be the captain going forward,” O’Neill said. “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.
“It’s probably a welcome break for Steven, if nothing else.
“He’s away from his club and I know these are difficult days there, so to be here getting to captain his country and knowing he will do so going forward will be important to him.
“Hopefully it’s a welcome distraction.”
While there have been few positives to draw from Rangers’ financial plight, O’Neill has been struck by the manner in which Davis has responded on the field to the club’s troubles.
“The main thing I’ve seen in Steven is the level of responsibility he has taken on the pitch and in contributing to games,”
the former Shamrock Rovers boss said.
“He’s always wanting to take the ball, he’s keen to be involved in the game. When things aren’t going well for the team he’s trying to initiate positive performances from others around him.
“I’ve watched him two or three times at Rangers in the past month when there has been a lot of pressure on the team and he was the player, above any other player, to lift the others around him.
“I’ve no doubt he will bring the same attributes to Northern Ireland.”
Davis would not answer questions about Rangers but was happy to talk about his pride, and surprise, at being made captain.
“I just thought Hughesy would come back 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. I’ve captained Rangers this season, which is something I’ve enjoyed and relished, and hopefully that experience is something I can bring to the table with Northern Ireland.
“Everybody has a different personality in terms of the way they approach it, but my personal opinion is to lead by example in the way I play.”
O’Neill can expect a warmer welcome at Windsor Park than his predecessor Nigel Worthington was afforded towards the end of an underwhelming Euro 2012 campaign, but he has appealed for patience from supporters.
With resources limited on and off the field, not to mention a World Cup qualifying group containing both Portugal and Russia, O’Neill wants expectations to be realistic.
“There is no secret the last campaign finished on a disappointing note,” he said. “The players know that, everyone knows that, but maybe the level of patience is not what it was in the past.
“Hopefully there isn’t that unrealistic weight of expectancy, which is something maybe the players have struggled to deal with. A bit of perspective would be nice.”
Of the 22 players on duty in Belfast on Tuesday, only Derby forward Jamie Ward is a doubt for the match after struggling with a thigh injury.