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Computerworld - Microsoft Corp. today told Yahoo Inc. that it has three weeks to agree to its unsolicited $42 billion takeover bid or face a proxy fight and possibly a lower offer.

"If we have not concluded an agreement within the next three weeks, we will be compelled to take our case directly to your shareholders, including the initiation of a proxy contest to elect an alternative slate of directors for the Yahoo board," said Microsoft CEO Steve Ballmer in a letter he sent to today Yahoo's board.

Ballmer added that if Microsoft was forced to take an offer directly to Yahoo's shareholders, it would most likely reduce its offer.

"It is unfortunate that by choosing not to enter into substantive negotiations with us, you have failed to give due consideration to a transaction that has tremendous benefits for Yahoo's shareholders and employees," Ballmer said. "We think it is critically important not to let this window of opportunity pass."

"If we are forced to take an offer directly to your shareholders, that action will have an undesirable impact on the value of your company from our perspective, which will be reflected in the terms of our proposal," Balmer wrote.

Yahoo, in a response Monday morning, said Microsoft's offer undervalues the company, but added that it is "not opposed to a transaction with Microsoft if it is in the best interests of our stockholders."

Ballmer said even though Microsoft made its offer to acquire Yahoo at 62% above Yahoo's market value on Jan. 31, the day before Microsoft giant made its offer, Yahoo has continued to drag out the process.

Microsoft's bid was initially worth $44.6 billion. However, a decline in Microsoft's share price means the offer is currently about $42 billion.

Yahoo rejected Microsoft's offer on Feb. 10, saying it undervalued the company.

Ballmer said although there has been some interaction between executives at the two companies, there has not been any meaningful negotiation to conclude a deal.

The companies met earlier this week, but because Microsoft executives did not raise their offer, Yahoo officials refused to talk further.

"We understand that you have been meeting to consider and assess your alternatives, including alternative transactions with others in the industry, but we've seen no indication that you have authorized Yahoo management to negotiate with Microsoft," Ballmer said in the letter.

Although there have been rumors about a deal that would merge Time Warner Inc.'s AOL Internet business with Yahoo, industry observers have said the mostly likely outcome is expected to be an acquisition by Microsoft, in part because no company wants to take on the software giant. Yahoo has also looked to Google Inc. and News Corp. to help stave off Microsoft, but to no avail.

"By any fair measure, the large premium we offered in January is even more significant today," Balmer said. "We believe that the majority of your shareholders share this assessment, even after reviewing your public disclosures relating to your future prospects."

In March, Yahoo told investors that the company will roughly double its operating cash flow from $1.9 billion to $3.7 billion and generate $8.8 billion in revenue, excluding costs, in 2010.

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