Yahoo shares were up 8.5 per cent to $14.49 in afternoon trading while Google was down 4.3 per cent at $351.18. Microsoft was down 3.6 per cent to $22.68. All three trade on Nasdaq.

"(Yahoo) investors are reacting favorably to the news (that the Google deal is off) as it might open the door to a possible deal with Microsoft, including a possible outright takeover of Yahoo," said Frederic Ruffy, options strategist at New York-based Web site WhatsTrading.com.

Google and Yahoo, Nos. 1 and 2 in the Internet search market respectively, announced the planned partnership in June but delayed implementation to allow the Justice Department to review it.

Google said it pulled out of the deal rather than face a protracted legal fight.

"After four months of review, including discussions of various possible changes to the agreement, it's clear that government regulators and some advertisers continue to have concerns about the agreement," Google legal officer, David Drummond, said in a blog posting.

"We're of course disappointed that this deal won't be moving ahead," he said.

A source close to the deal said that Microsoft's decade-plus-long legal battles with the Justice Department over antitrust matters had been a lesson for Google. "Most observers would say that they (Microsoft) did allow themselves to get distracted," the source said.

Advertisers hotly opposed the search partnership, arguing that Google and Yahoo's dominance of the market could mean they would raise prices. But the source said regulators were more concerned that Yahoo "over time would become overly reliant on our system and would over time exit the search market."

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