May 1 (Bloomberg) -- Microsoft Corp. directors failed to decide on the next step in the pursuit of Yahoo! Inc. yesterday, leaving open the debate over whether to walk away from the $44.6 billion bid or fight to replace the Internet company's board.

Chief Executive Officer Steve Ballmer is undecided on what to do, and his allies don't know whether he will give up or mount a hostile takeover, the Wall Street Journal reported last night on its Web site, citing people familiar with the matter.

Microsoft examined a price of $32 to $33 a share in recent days, more than the initial $31 cash-and-stock bid, the newspaper said. Raising the offer would be one way for Microsoft, the world's biggest software maker, to clinch a friendly deal with Yahoo or make it easier to win a proxy fight to oust the board.

``Microsoft should sit down with Yahoo and try to find some kind of compromise as both companies would benefit greatly from a deal,'' said Stephen Pope, chief global strategist at Cantor Fitzgerald in London. ``A hostile bid is not an attractive option as messy takeover fights are never a good start to the integration of two companies.''

Ballmer has stood firm on the price when speaking in public and has to balance holding out to avoid over-paying and angering his shareholders with the need to pay enough to succeed in buying Yahoo and building a bigger challenger to Google Inc. in the $41 billion online advertising market.

Yahoo wants an offer in the high $30s, and investors have signaled they would prefer as much as $37, the Journal said. Microsoft is reluctant to start a hostile takeover and may walk away from the offer, the Journal said.

Decision Due

Microsoft, based in Redmond, Washington, has said it will make a decision this week. Representatives declined to comment. Yahoo spokeswoman Diana Wong didn't respond to a phone message.

Microsoft rose 88 cents to $29.40 in Nasdaq Stock Market trading at 4 p.m. New York time. That values Microsoft's bid at $29.48 a share. The stock has dropped 17 percent this year. Sunnyvale, California-based Yahoo, which has gained 15 percent this year, declined 60 cents to $26.81.

Yahoo CEO Jerry Yang says the offer undervalues his company. Investments and acquisitions will help attract more visitors and boost Yahoo's value, he said. Legg Mason Inc. fund manager Bill Miller, Yahoo's second-biggest shareholder, said in February that Microsoft needed to boost its bid.

After rejecting the offer as too low, Yahoo sought other deals, such as a combination with Time Warner Inc.'s AOL unit. Ballmer gave Yahoo until April 26 to make a deal. The deadline passed without an agreement.

Competition

``Steve Ballmer's not the sort of person who runs away from a fight,'' David Buik, a market analyst at BGC Partners, said in an interview this week. ``He likes to take things head-on.''

Microsoft, owner of the third-most popular Internet search engine, is targeting Yahoo to step up competition with industry leader Google. Advertising linked to search results accounts for more than half of Internet ad sales, a market that Microsoft says may nearly double to $80 billion by 2010.

Microsoft Chief Financial Officer Chris Liddell said last week that the company may pursue a proxy fight or walk away from the bid. The company would consider other investments and partnerships to bolster its online business, he said.

Investors such as Jane Snorek at First American Funds in Minneapolis said after the bid was announced that a combined Microsoft and Yahoo would only continue to lose market share to Google. Ballmer himself told analysts in July 2006 that buying Yahoo wouldn't help Microsoft improve its search business, because only Google has a better product than Microsoft.

Pessimism

Microsoft is increasingly likely to drop its bid for Yahoo as negotiations stagnate, Sveinn Palsson, a Credit Suisse Group derivatives strategist in New York, said in a note yesterday.

The options market is pessimistic Microsoft's bid will be accepted, with the implied probability of a deal happening ``significantly lower than two months ago.''

Palsson recommends investors buy Yahoo put ``spreads'' that combine buying a July $25 put with selling two July $20 puts to partially hedge investors who own the shares, as long as the stock remains above $20.

Put options give investors the right to sell a specific quantity of a stock for a set price at a certain date. Sellers generally bet that the stock will fall.

To contact the reporter on this story: Amy Thomson in New York at athomson6@bloomberg.net.

Last Updated: May 1, 2008 16:14 EDT