Thorpe closed with a 4-under 68 to complete the event with a 72-hole record score of 20-under-par 268. Watson posted a 5-under 67 to finish second at 17-under-par 271.
'I think this week I probably pushed myself to the absolute limit,' said Thorpe, who earned $440,000 for the win. 'I don't think I could play any harder.'
Tom Kite, one of many who made a run at the leaders during the final round, finished alone in third place at 15-under-par 273 after closing with a 67.
Thorpe and Watson were close throughout the round. Watson, the 2002 champion, birdied the first and eighth to get within two of the leader, as Thorpe bogeyed No. 7 before birdieing the eighth at Sonoma Golf Club.
Thorpe, who also won the Long Island Classic earlier in the season, moved three clear of Watson with a birdie at the 11th. At the par-3 12th, Watson dropped his tee shot within a foot of the cup for a kick-in birdie to get back within two of Thorpe.
While those two were battling amongst themselves, Tom Jenkins and Gil Morgan quietly climbed to 14-under. However, neither of them would get any closer.
Watson lost his drive left off the 13th tee, but was able to find the front right corner of the green with his second to the par-5 hole. Thorpe laid his second shot up in the rough and only managed a par. Watson two-putted for birdie to get within one stroke.
Each man two-putted for par on Nos. 14 and 15 to remain at 17-under and 16- under respectively. Kite, meanwhile, ran home a lengthy eagle putt on the 16th to get to minus-15. He could only par in though.
The turning point came at the 16th. Watson and Thorpe both missed the green short. Watson's pitch from the rough ran past the hole. Thorpe stepped up and rolled in an eagle putt from over 65 feet out to jump to 19-under.
'No. 16 was a turning point,' said Thorpe, who hit all 18 greens in regulation on Sunday. 'I finally hit the fairway, but I didn't catch the drive solid. Now I know I can't get it home and I need to keep it left. I hit a 3-wood about a yard short of the green.
'Jenkins was in the left rough and Watson was just behind me in the left rough, so I got two nice reads from their chip shots. Putting like that, you want to lag it up. I hit a putt there, perfect line, perfect speed, and it went in.'
Watson, who won two majors this season, answered by converting his birdie putt, but still trailed by two strokes with two holes to play.
On the par-4 17th, Watson's birdie try went halfway down and popped out of the hole. He tapped in for par, but it was not enough. Thorpe converted a 12-foot birdie putt on the same hole to move three shots in front of Watson.
The duo both two-putted for par on the closing hole, giving Thorpe the winning score, 20 under, that he predicted earlier in the week.
'We talk about it all the time. You guys think we don't get nervous out there,' Thorpe said. 'You can feel it out there, believe me. To be playing with a guy like Tom Watson, I played the second shot on 18, I waited for him to walk up together, he said 'Thorpe you hung in there, the balls didn't fall early for you, but you made it when you had to and it was a great plan.'
'Coming from a player that's won 39 times on the PGA Tour, and eight majors and six times on the Champions Tour, and two majors this year, that's pretty good advice. He didn't have to say that.'
With the victory, Thorpe climbed to No. 2 on the Champions Tour money list and also finished second in the race for the Charles Schwab Cup.
Watson, who won the JELD-WEN Tradition and Senior British Open earlier in the year, claimed both the money title and the $1,000,000 annuity that comes with the Charles Schwab Cup.
'It looked as if Thorpe was going to leave the door open all day until he holed that putt on 16,' Watson said. 'He deserved to win because of the way he played today. He didn't putt very well, but they went in when it mattered.'
After the round, Watson gave out more than compliments to his fellow golfers.
He announced that the bulk of the annuity, which will be paid out over the next 10 years, will be donated to ALS research and patient services. Watson's longtime caddie, Bruce Edwards, is battling ALS, more commonly known as Lou Gehrig's disease.
'We're going to use it for ALS and the other charities I give to every year will also benefit, but we going to concentrate on finding a cure for this damn disease, and we're going to make it,' said Watson as he acknowledged Edwards.
'It basically shows how big Tom Watson's heart is,' said Thorpe of the classy gesture by Watson. 'I think we knew it was coming. Tom and Bruce are very, very close. Hopefully they can find some type of cure so Bruce can be with us for many, many more years to come. Sometimes a three-putt on a green, a bad shot just isn't the worst thing in the world.'
Jenkins, Hale Irwin and Morgan shared fourth place at 14-under-par 274. Larry Nelson and Tom Purtzer were one stroke farther back at minus-13.