Google has abandoned it advertising agreement with Yahoo, citing the heat it was getting from skeptical advertisers and hawkish government regulators.

Critics of the deal said it would create a monopoly because Google and Yahoo dominate more than 90 percent of the U.S. search advertising market, giving advertisers fewer outlets for their business. While Google disputes that view, insisting that the deal would have been good for publishers and advertisers, the company said in a statement that it is ending the deal to avoid a prolonged legal battle that might damage the company.

The announcement was made by

This is not surprising, because the deal has been on the ropes for some time. The question now is, what next?

Yahoo has been adrift for the past year. Its stock price has been pummeled as Google continues to take away market share in search advertising and other areas. Yahoo needs to do something to stop its decline. Notably, however, Yahoo’s stock price jumped this morning in the first hour of trading after Google’s announcement about the deal was made, even as the wider stock market dropped slightly. As of 7:55am, its stock is up four percent, to $13.86. But that still leaves Yahoo’s stock at less than half of its value a year ago. [Update: Turns out Yahoo’s stock jumped because of a rumor that Microsoft was close to acquiring Yahoo. Oddly, even though the companies have denied it, the stock has gone up even further. It is now up 5.6 percent. I just talked with Boomtown’s Kara Swisher, who said she has gotten bombarded with calls from short sellers trying to manipulate the stock. She’s convinced there’s nothing to this rumor, even though the stock price is still up.]

Eyes will turn now to Microsoft, which might be encouraged to renew its bid to acquire Yahoo. Even if Yahoo does try to cozy up to another competitor, AOL, by attempting to acquire its advertising properties, Microsoft may still be interested in acquiring Yahoo after that move — a possibility we reported about in September.

Here’s the announcement.

In June we announced an advertising agreement with Yahoo! that gave Yahoo! the option of using Google to provide ads on its websites (and its publisher partners’ sites) in the U.S. and Canada. At the same time, both companies agreed to delay implementation of the agreement to give regulators the chance to review it. While this wasn’t legally necessary, we thought it was the right thing to do because Google and Yahoo! have been successful in online advertising and we realized that any cooperation between us would attract attention.

We feel that the agreement would have been good for publishers, advertisers, and users — as well, of course, for Yahoo! and Google. Why? Because it would have allowed Yahoo! (and its existing publisher partners) to show more relevant ads for queries that currently generate few or no advertisements. Better ads are more useful for users, more efficient for advertisers, and more valuable for publishers.

However, 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. Pressing ahead risked not only a protracted legal battle but also damage to relationships with valued partners. That wouldn’t have been in the long-term interests of Google or our users, so we have decided to end the agreement.

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