Microsoft Corp. walked away from its bid for Yahoo Inc. after failing to agree on a price, a setback to the software maker's efforts to catch Google Inc. in the online advertising market.

The world's largest software maker said it offered to raise its $44.6 billion bid by about $5 billion, to $33 a share. Yahoo demanded $37, Microsoft said yesterday in a statement.

"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," chief executive officer Steven Ballmer said in the statement.

Microsoft, whose Internet business lost $228 million last quarter, now faces the challenge of finding alternatives to buying Yahoo, a purchase that would have tripled its share of the U.S. Web search market. The decision also leaves Yahoo CEO Jerry Yang to prove he can revive sales growth and the stock price by keeping the company he cofounded independent.

"Unbelievable," said Laura Martin, an analyst at New York-based Soleil Securities Corp. "This is management putting its employees and its job security ahead of current Yahoo shareholders' interest."

She estimated Yahoo shares would fall $8, or 28 percent, tomorrow because Microsoft's withdrawal combined with concern about the economy and the advertising market would weigh on investors.

Yahoo, the second-most-popular Internet search engine, rose $1.86 to $28.67 Friday in Nasdaq Stock Market trading. Microsoft fell 16 cents to $29.24.

Yahoo spokeswoman Diana Wong said she did not immediately have any comment.

Ballmer had pledged to abandon the bid before he would overpay, saying Thursday that he wouldn't pay "a dime above" Yahoo's value. A month before, he gave the Sunnyvale, Calif.-based company three weeks to come to terms on a takeover, a deadline that passed a week ago.

Yahoo had said its rank in the U.S. search market and its Asian operations warranted a higher bid.

A person familiar with the matter said last week that the company might agree to an advertising partnership with Internet-search market leader Google, increasing pressure on Microsoft to raise its offer.

Yahoo and Microsoft remain a distant second and third behind Mountain View, Calif.-based Google in Web search queries.

Google outsold Microsoft in Web ads by 7-1 in its last fiscal year and handles six times as many search queries in the United States, according to ComScore Inc. in Reston, Va.

"It would certainly be challenging for them to do it - to go it alone and make any real headway against Google," said Donovan Gow, an analyst at American Research Technology in San Francisco. "They're miles behind."

On April 24, Microsoft reported a 24 percent quarterly drop in sales of Windows and forecast earnings that may miss analysts' estimates.

"With or without a Yahoo combination, Microsoft is focused on the online advertising market," chief financial officer Chris Liddell said in a conference call after the third-quarter results. "The transaction has been anything but speedy, and has been characterized by what would appear to be unrealistic expectations of value."

Yang rejected Microsoft's cash-and-stock bid Feb. 11, calling the offer too low and pledging to seek alternatives. Yahoo and Time Warner Inc.'s AOL were close to an alliance, a person with knowledge of the talks said on April 9.

Yahoo's stock had declined 32 percent in the year before Microsoft's offer as Google attracted more users, and advertisers switched to social-networking sites such as Facebook.com and News Corp.'s MySpace social-networking site.

On April 22, Yahoo said first-quarter net income rose to $542.2 million, or 37 cents a share. The company's forecast for the current quarter was in line with analysts' estimates. Less than three weeks before that, Ballmer said an economic slump in the United States had hurt Yahoo's business.

Microsoft has other options, Charles Di Bona, an analyst at Sanford C. Bernstein & Co. in New York, said in an April 25 note.

The company could buy AOL and then go after MySpace, he said. That would give Microsoft a substantial presence on the Internet, probably at a much lower cost than buying Yahoo, Di Bona said.