Watson would have been a restricted free agent at the end of this season but AFL.com.au can reveal he has penned the contract, which will see the reigning Brownlow medallist play out his career in the red and black.
"It's the right thing in terms of where I want to be," the skipper said on SEN 1116 on Thursday.
"I was happy at the football club. I didn’t want to leave and I am happy to stay."
Watson said he was unaware of any clubs to have made him an offer to move away from the Bombers.
"I never instructed my management to do so and they never told me there were offers from elsewhere.
"If they were doing their due diligence they would have put something forward, so my understanding is that it was no."
The 28-year-old has won the best and fairest three of the last four years at the club and has grown into one of the competition's elite midfielders after a challenging start to his AFL career.
The 163-gamer has continued at the same pace this season during the Bombers' hot start, averaging almost 30 disposals an outing and being a favourite to claim back-to-back Brownlows.
In last Saturday night's win over Richmond, Watson put in a best-on-ground showing, collecting 28 disposals and three goals.
After the game coach James Hird praised Watson's leadership during the club's off-field dramas this year.
"He's abnormal to a certain extent with what he's been able to do with his players," Hird said.
"You don't expect that from normal people.
"Right from the first bounce, the way he started the game and the way he led his team when they came back at us, he was the one who drove us forward.
"It was as good a leadership performance as I've seen in football considering what's going on around him.
"When everything finishes, when everything's washed up, I think the person he is will rise even further because of what he's done to get his team to where it's got to."
Watson, the son of Bombers champion Tim, joined the club under the father-son rule at the 2002 draft.
He struggled to make an impact in his first few seasons at the club and was famously dropped for the last game of Kevin Sheedy's coaching era at the club in 2007, a turning point in Watson's career.
From there Watson worked hard to acquire the fitness base needed at AFL level, and won his leadership role under former coach Matthew Knights.
His football smarts, clearance work and slick hands have been central to his rise, and he is viewed as one of the competition's most respected players.
Follow AFL website reporter Callum Twomey on Twitter at @AFL_CalTwomey.
