The institute, codirected by a former York police officer, Michael Perelman, says on its website that it has offices in Philadelphia, Washington, and Jerusalem. Perelman said recently that it gathers threat information from a variety of sources.
The institute's contract came under intense scrutiny when tracking reports it produced showed it was monitoring scores of groups with no history of violence.
In his resignation letter, Powers told the governor he had reached the decision after "thorough examination and reflection" on "emerging events surrounding the credibility" of the information provided by the institute.
Rendell said he learned of the contract only last month and immediately ordered it canceled when it expires at the end of this month. He said he was deeply disturbed by the institute's activities.
He said Friday he did not ask Powers to step down but accepted his resignation effective Oct. 8.
"I do so out of mutual concern for the function of homeland security and the belief it's far too important to be set back by the distraction resulting from one operation of one man," Rendell said Friday.
Rendell, who leaves office in January, said he would await the findings of a task force led by his chief of staff, Steve Crawford, before determining when and whether he will name a replacement.
Democrats and Republicans in the legislature said Powers made the right move by resigning.
Sen. Lisa Baker (R., Lehigh), chairman of the Senate Committee on Veterans and Emergency Preparedness, convened a hearing on the issue, calling the monitoring of groups "toxic to the public trust."
"Given the troubling revelations about the security contract and his continuing defense of it, his position was untenable," Baker said of Powers. "So his decision to resign is the right one. His departure opens the door to some badly needed changes, but restoring credibility to the operation now looks to be a monumental task."
Sen. Jim Ferlo (D., Allegheny), who called for the resignations of Powers and Pennsylvania Emergency Management Agency Director Robert French, said Powers' departure was a step in the right direction.
"I continue to remain concerned about the violative nature of his activities," Ferlo said. "It is important that we end this chapter and that we never see the day when a government agency would engage in the suppression of people's rights."
The attention followed revelations that the institute was reporting on the activities of citizen groups that posed no obvious threat to public safety, including student organizations, gay-rights supporters, advocates for education and low-income services, and opponents of natural gas drilling.
That information was disseminated in thrice-weekly bulletins by the Homeland Security Office to law enforcement as well as a number of private companies.
Rendell said he was not aware of the contract or the bulletins until the recent controversy began.
But at least one high-level Rendell official, Donna Cooper, was quoted in an Inquirer story in July questioning the contract.
Powers, a retired Army Special Forces colonel, has said the state Office of Homeland Security hired the firm because other state and federal agencies weren't providing information about local activity he thought was critical to protect nearly 4,000 sites in Pennsylvania.
At a state Senate hearing this week, Powers issued a blanket apology to any group or individual who felt their constitutional rights had been infringed upon because they were listed in the bulletin.
State police officials testifying at the same hearing blasted the Office of Homeland Security for ignoring issues they raised about the quality of information the institute was providing, saying it was useless, inaccurate, and caused unnecessary alarm.
Powers, whose salary is $107,678, has served as Homeland Security director since 2006.
His office was folded into the Pennsylvania Emergency Management Agency three years ago.
Shelly Yanoff, director of the advocacy group Public Citizens for Children and Youth, said she was surprised when she learned in July from an Inquirer column that her group was on the watch list.
Yanoff said her group rallies peacefully at the Capitol several times a year to try to secure adequate funding for education and government services for needy families.
"It's a misuse of the function of government," she said. "It's laughable on one hand; on another, it's a serious infringement."