NEW YORK (Reuters) - Yahoo Inc (YHOO.O: Quote, Profile, Research), responding to a three-week deadline issued by Microsoft Corp (MSFT.O: Quote, Profile, Research) to accept its $42 billion takeover bid, again rejected the deal for undervaluing the Web pioneer.

In a defiant open letter to Microsoft Chief Executive Steve Ballmer on Monday, Yahoo said the software giant's threat of a proxy battle was counterproductive and Yahoo would only be open to a better deal.

"Our board's view of your proposal has not changed," said the letter, signed by Yahoo Chairman Roy Bostock and Chief Executive Jerry Yang. "We continue to believe that your proposal is not in the best interests of Yahoo and our stockholders."

Ballmer on Saturday set a three-week deadline for Yahoo to agree to its cash-and-stock offer or risk seeing the bid lowered, citing a deteriorating economy and market for Internet stocks, as well as a decline in Yahoo's share of the Web search and advertising business.

Yahoo countered that its business is in good shape and suggested the software giant should look to the value of its own enterprise.

"As a result of the decrease in your own stock price, the value of your proposal today is significantly lower than it was when you made your initial proposal," Yahoo's letter said.

When Microsoft first announced its bid on February 1, the deal valued Yahoo at $31 per share, or $44.6 billion in total, representing a 62 percent premium to Yahoo's market price.

But a fall in Microsoft's stock price means the proposal now values Yahoo at only $29.62 per share.

Yahoo shares slipped 2.3 percent to $27.69 in early Nasdaq trading. Microsoft shares rose 22 cents to $29.38, also on Nasdaq.

If the two sides can agree to a deal, it would be the biggest takeover in the high-tech industry. But Yahoo directors -- whom Microsoft hopes to convince to negotiate a friendly deal or else face a battle for their jobs at Yahoo's next annual meeting -- want more.

"We have continued to make clear that we are not opposed to a transaction with Microsoft if it is in the best interests of our stockholders," the letter said. "Our position is simply that any transaction must be at a value that fully reflects the value of Yahoo, including any strategic benefits to Microsoft, and on terms that provide certainty to our stockholders."

Yang and Bostock went on to charge that Ballmer's letter "mischaracterizes the nature" of their talks so far, calling his assertion that Yahoo had refused to enter into negotiations to conclude an agreement "particularly curious."

"Moreover, Steve, you personally attended two of these meetings and could have advanced discussions in any way you saw fit," the letter said.

Directors of Sunnyvale, California-based Yahoo continue to explore alternatives, the company said.

Yahoo shareholders and analysts say the company's best options are to find an ally to help demonstrate Yahoo is worth more as an independent player, or surprise the market with a strong show in its quarterly results on April 22.

The consensus on Wall Street is that no "white knight" will emerge to whisk Yahoo away from Microsoft and its proposed cash-and-stock offer currently valued at $42.2 billion.

(Editing by Maureen Bavdek)

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