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The collapse of talks between the companies, ended Microsoft's hopes of buying the web portal to stiffen its competition with Google for internet advertising and software.

Microsoft had raised its bid for Yahoo to 44.6 billion dollars, or 33 dollars per share, as negotiations between the firms intensified over the weekend, but the increase had failed to win over Yahoo executives who had insisted on a higher price of 37 dollars per share.

"Despite our best efforts, including raising our bid by roughly 5 billion dollars, Yahoo has not moved toward accepting our offer. After careful consideration, we believe the economics demanded by Yahoo do not make sense for us, and it is in the best interests of Microsoft stockholders, employees and other stakeholders to withdraw our proposal," Microsoft chief executive Steve Ballmer said in a statement.

In a letter to Yahoo chief executive Jerry Yang, Ballmer stressed that he believed a merger "would have created real value for our respective shareholders and would have provided consumers, publishers and advertisers with greater innovation and choice in the marketplace." However, Microsoft was not willing to increase its bid by a further 5 billion dollars to meet Yahoo's demand.

In a statement in response to the breakoff of negotiation, Yahoo maintained that Microsoft's price was insufficient.

"From the beginning of this process, our independent board and our management have been steadfast in our belief that Microsoft's offer undervalued the company and we are pleased that so many of our shareholders joined us in expressing that view," chairman Roy Bostock said.

Ballmer also said his company would attempt a hostile takeover of Yahoo, calling it "not sensible for Microsoft to take our offer directly to your shareholders."

He urged Yahoo against responding by forming an online advertising deal with rival Google. Such a deal would devalue Yahoo's market position by decreasing competition and making Yahoo irrelevant in the online advertising sector, essentially eliminating any further merger opportunities with Microsoft, Ballmer wrote.

The three-month long discussion of a Yahoo takeover began with a 45-billion-dollar offer that had shrunk to 41.9 billion dollars by last weekend, when a deadline passed for Yahoo to accept the offer. The internet firm had originally dismissed the bid as undervaluing the company, even though it represented a premium of 62 per cent on the company's pre-offer share price.

Yahoo's Yang said that the company would now be able to move on.

"With the distraction of Microsoft's unsolicited proposal now behind us, we will be able to focus all of our energies on executing the most important transition in our history so that we can maximize our potential to the benefit of our shareholders, employees, partners and users," he said.

Media reports on Friday said Yahoo and Google were close to reaching an advertising partnership that would see Google's ads appearing on Yahoo sites. The move could boost Yahoo's revenues by approximately 1 billion dollars annually since Google's ads have higher click-through rates than Yahoo's.

However the move could face regulatory hurdles.