The non-exclusive partnership will add $250-450 m to Google link's operating cash flow.
The battle for dominance of the web search business took a decisive turn Thursday as Yahoo sealed an alliance with search giant Google, leaving rival suitor Microsoft out in the cold as it hunts for a way to revive its own flagging internet fortunes.
The alliance between the two biggest search companies, which many antitrust experts have said would face intense scrutiny, will put Google adverts alongside Yahoo's search results and on other web pages in the US and Canada.
To reduce the risk of a regulatory backlash, Yahoo said the partnership would be non-exclusive and would mean that Google ads would sit alongside others generated by its own advertising system as well as those supplied by other companies, potentially including Microsoft.
The development followed an announcement earlier in the day that Yahoo had called off all talks about an alliance with Microsoft.
"Clearly, it is time to move on," said Jerry Yang, Yahoo's embattled chief executive, who has endured intense criticism from some Yahoo shareholders since Microsoft abandoned a full takeover bid last month.
According to people familiar with Microsoft, the software company has more recently proposed paying more than $7 billion, or $35 a share, for a 16 per cent stake in Yahoo and taking over its search business in a deal that would have boosted the internet company's profits by $1bn a year. However, Yahoo said it had decided that retaining search was a strategic necessity.
Yahoo executives said the Google link would add $250-450 million to operating cashflow in its first year, and the full benefits could eventually reach $800 million a year.
Yahoo's shares slumped by 10 per cent in late trading as expectations of a full takeover faded, hitting their lowest point since Microsoft announced its unsolicited bid this year.
In spite of that, some hedge fund investors continued to argue that an eventual acquisition by Microsoft was the most likely outcome.
"Microsoft will either have to come back to the table or cede the search business to Google," said one.
With Yahoo's shares slumping to $23.50 on Thursday, this person added that Microsoft stood eventually to buy Yahoo at less than the $33 a share it offered in early May, a price that was rejected as too low by Yang.
Microsoft also left the door open for more talks an an alliance, though not a full acquisition, as it said that the offer of a deal that stopped short of a full acquisition "remains available for discussion". Yahoo's deal with Google calls for it to pay a $250 million break-up fee if it is acquired within two years.