Google announced a non-exclusive advertising services agreement with Yahoo, only hours after a decision by Microsoft to walk away from talks to acquire Yahoo.
Meanwhile, an important antitrust voice in Washington said he would "closely examine" the deal. (More below.)
The ad deal gives Yahoo the option to display Google ads alongside its own natural search results. The agreement has a term of up to 10 years.
Google said the agreement, which applies to the United States and Canada, will also enable interoperabililty between the two online media firms' instant messaging services.
Financial terms of the pact were not disclosed.
"This commercial agreement provides Yahoo with the opportunity to deliver more relevant ads to users and provide advertisers and publishers with better advertising technology to help them succeed in their own businesses," Eric Schmidt, chairman and CEO of Google, said in a statement. "This agreement will preserve the competitive and dynamic online advertising space."
Senator Vows Scrutiny
The chairman of a U.S. Senate antitrust subcommittee said on Thursday lawmakers would "closely examine" the collaboration between Google and Yahoo
Democratic Sen. Herb Kohl of Wisconsin said the deal between Google and Yahoo "raises significant competition concerns."
"The consequences for advertisers and consumers could be far-reaching and warrant careful review, and we plan to investigate the competitive and privacy implications of this deal further in the Antitrust Subcommittee," Kohl said in a statement.
Microsoft Bows Out
Earlier Thursday, Yahoo said that Microsoft was no longer willing to acquire it for $33 per share.
"The conclusion of discussions follows numerous meetings and conversations with Microsoft regarding a number of transaction alternatives, including a meeting between Yahoo and Microsoft on June 8 in which Chairman Roy Bostock and other independent Board members from Yahoo participated," Yahoo said.
"At that meeting, Microsoft representatives stated unequivocally that Microsoft is not interested in pursuing an acquisition of all of Yahoo, even at the price range it had previously suggested," the statement said.
Yahoo added that it determined that an acquisition of its search business alone by Microsoft was not in the best interest of its shareholders.
Microsoft said in a statement that it's not interested in "rebidding" for all of Yahoo, but that it was still open to an "alternative transaction" with the firm.
Microsoft had recently offered $35 a share for 16 percent of Yahoo as an alternative to an outright acquisition of the company, the Wall Street Journal reported.
Shares of Yahoo finished more than 10 percent lower Thursday at $23.52, while Microsoft shares rose 4.13 percent to $28.24.
Google shares finished up 1.42 percent, at $552.95.
See more in the accompanying CNBC video report.
On Monday, Yahoo President Susan Decker told CNBC that Yahoo remained open to deals with other firms if it failed to reach an agreement with Microsoft. "Our board remains absolutely open to any conversation w any company that would maximize shareholder value," she said.
Google's dominance in Web search prompted Microsoft to offer up to $47.5 billion to buy Yahoo. Microsoft hoped an acquisition would accelerate its ability to capitalize on Internet advertising growth and better compete with Google, which is increasingly fighting for the same audience of Internet users.
"It was pretty clear it was going to be one or the other. Yahoo wasn't going to do a deal with Google and then partner with Microsoft," Global Crown Capital analyst Martin Pyykkonen said.
The more recent proposal by Microsoft to only buy Yahoo's search business did not fit into Yahoo's view of benefiting from growth in both the search and display advertising businesses combined.
Yahoo faces mounting pressure from investors, including billionaire Carl Icahn, who urged the company to seal a deal with Microsoft but for a higher price. Icahn said a partnership with Google should only be a second choice.
Icahn could not immediately be reached.
- Reuters contributed to this report.