The 43-year-old had previously been head of academy coaching at Easter Road, while also helping with coaching of youth teams.
He departed the club in 2014 to take up a coaching role with Falkirk.
Since 2017 McDonaugh has been at Edinburgh City where he has helped the club progress on and off the field.
Having taken over from Gary Jardine, he consolidated the club in League Two before leading them to a third and second place finish.
Earlier this year, McDonaugh moved upstairs into a sporting director role with Gary Naysmith over as manager.
In a statement the club said the approach from Hibs was “unwanted” but “following discussions with James, it became clear that this was something he was keen to explore”.
“I’d like to thank everyone at the club, the directors, supporters, volunteers, players and staff for the near four years I have been at the club," McDonaugh told ECFC TV.
“There has been so many great times and memories to take away. I’ve formed some great relationships throughout the club but I couldn’t turn down the opportunity to get back coaching and being on the training pitch daily.
“Thank you and good luck to everyone at City in the future; the Club will always be special to me and I will continue to look out for their results every week.”
After taking up the position of Sporting Director he has worked extremely hard to support the board and first team management, while at the same time putting the building blocks in place for our Youth Section to develop.
City's chairman Jim Brown paid tribute to the work McDonaugh did at the club, helping improve the “professionalism”.
His work since becoming sporting director has seen him support both the board and the management team, while “putting the building blocks in place” for the club's youth section to develop.
Brown said: “James came into the Club when we were battling to maintain our SPFL future and he helped us consolidate our position and introduced a greater level of professionalism to the way the first team was organised, both on and off the field.
"As a club we backed him and he delivered our highest league position in 2018, then improved on that the following season.
"I would like to thank him for all the hard work and determination he has shown during his time here; he has played a big part in the club’s development and I wish him nothing but success in the future.”
In June, Edinburgh City lost their assistant manager Grant Murray to Queen’s Park.
Murray had been combining his role working with Naysmith with a position at Hibs.
City picked up their first win of the league campaign on Friday night, defeating Stenhousemuir 1-0 thanks to a Ryan Shanley goal with Brian Schwake saving a penalty.
It followed 2-0 defeats to both Albion Rovers and Forfar Athletic to start the season.