Talks intensified this week after Yahoo spent three months hunting for alternatives to the deal. The original cash-and-stock bid of $31 a share, or $44.6 billion, has fallen to $29.40 a share because of Microsoft's declining stock price.
A higher offer may win over Yahoo's board, eliminating the need for Microsoft Chief Executive Officer Steve Ballmer to go to shareholders with a hostile offer, which might have spurred an employee exodus. A deal also may halt Yahoo's efforts to forge an online advertising partnership with rival Google.
"The impact of the decision is wide because a hostile bid is not in the interest of either Microsoft or Yahoo," said Andy Miedler, an analyst at Edward Jones & Co in St Louis. He has a hold rating on Microsoft's shares. "It's certainly easier to raise the offer.''
Microsoft is counting on a Yahoo marriage to help it challenge Google, the leader in the $41 billion online advertising market. Yahoo has the most visited US website and handles more internet queries than any company besides Google. Microsoft, the world's largest software maker, ranks third in online searches.
Yahoo climbed $1.86, or 6.9 per cent, to $28.67 yesterday in Nasdaq Stock Market trading. Redmond, Washington-based Microsoft fell 16 cents to $29.24, while Google dropped $11.79 to $581.29.
More From This Section
Yahoo spokeswoman Diana Wong and Microsoft spokesman Frank Shaw declined to comment.
Worth more?
Yahoo CEO Jerry Yang has said Microsoft's original offer "substantially undervalues" his company. Yahoo is worth more because of investments in Asia and its position in the internet search market, he said. Until now, Ballmer has stood firm on the price.
Yahoo's potential agreement with Google may have changed his mind. Yang plans to make a deal to use ad software from Google within a week unless he agrees to sell to Microsoft, said the person, who asked to remain anonymous because the takeover negotiations are private.
Yahoo, based in Sunnyvale, California, ran a test last month of Google's ad system, applying it to 3 per cent of its internet searches. A permanent agreement may help Yahoo squeeze more money from queries, generating more than $1 billion in additional cash flow, said Mark Mahaney, a Citigroup analyst in San Francisco.