The governor traveled to the 125 year-old Folsom State Prison east of Sacramento to sign Democratic Senator Gloria Romero's bill.
Romero said the measure expresses her corrections philosophy.
"There is something that we call redemption. There's an opportunity for people who make mistakes to pay for their mistakes, but to turn their lives around."
The newly created California Department of Corrections and Rehabilitation replaces the old Youth and Adult Correctional Agency with Rod Hickman remaining in charge as secretary of the new Department. Governor Schwarzenegger told reporters the new emphasis on rehabilitation will not compromise the state's first duty to protect public safety.
"It's guaranteeing every Californian the freedom from fear and also the right not to become a victim."
Schwarzenegger called the new law just a first step in reforming the state's prison system.