As I predicted, Yahoo rejected Microsoft's hostile offer because the offer substantially undervalues Yahoo!  I wish that companies would be more honest with their rejections but everyone has to play the game.

The key question for Yahoo! is whether it wants a higher price, whether it wants to remain independent at all costs (a scorched earth approach) or whether it is looking for a partnership with someone like Google to avoid being acquired by Microsoft.  From what I remember, many Yahoos hate Microsoft with a passion and would consider being acquired by them as the ultimate in humiliation.  I do not think that just say no defense will work for Yahoo! so I would expect them to look for some strategic initiative which will buy some time for them.

For Microsoft, they will have to choose how to proceed in light of this rejection:

• Walk Away -- Microsoft could decide that they made their best offer and walk away.  I doubt that they will approach it this way since they have invested too much effort and have wanted to buy Yahoo! for several years.
• Proxy Contest  -- Microsoft could engage in a proxy contest to gain control of the Yahoo Board of Directors in the upcoming annual shareholder meeting.  Very hard to win a proxy contest especially when you are not a seasoned veteran in these contests. 
• Tender Offer -- Microsoft could take its offer directly to Yahoo's shareholders.  Most shareholders would be receptive to the premium that Microsoft is offering.  It is doubtful that Yahoo's share price would rise over 60% from its organic earnings (which it is based upon Microsoft offering) especially since its CEO said that they faced headwinds this year.  Absent the Microsoft offer, Yahoo! would be trading in the teens rather than close to $30 a share.  Add to that fact that a significant portion of Yahoo shareholders are now hedge funds looking for a quick profit, the shareholders seem to be lining up to be a receptive audience for Microsoft.  The problem with this is Yahoo has a poison pill which could stop the tender offer in its tracks.  More later on the likelihood that they would follow through on the poison pill.
• Negotiated Offer -- Microsoft could always raise their offer by $5 a share and exert pressure on Yahoo's Board to accept it.

I think that most likely scenario is Microsoft will first raise its offer but stoke Yahoo's fears with the threat of a tender offer.  I think that Yahoo's shareholders are very receptive to selling to Microsoft.  While Jerry Yang was right about Yahoo being worth a lot of money, the shareholders may not want to bet their investment on whether his strategy and execution will work.

The best outcome for shareholders would be that Yahoo! re-positions itself and starts the growth engine that it once was.  If they succeed in that, Yahoo's share price will end up being higher than the Microsoft offering price.  One of the key questions is how long for it to reach that level.

Next best outcome is take Microsoft's offer with its guaranteed price. 

The worse outcome occurs if Yahoo does not consummate this deal and Jerry and his management team are unable to follow through on their visions.  Yahoo! will continue to lose value.  This outcome is a disaster for shareholders.

In evaluating what is the best to do, we are faced with imperfect information similar to the old Prisoner's Dilemma.  In that economic scenario, prisoners are forced to make a choice absent perfect information. They do make a choice that they feel is their best alternative but it turns out that they choose a less than optimal outcome as a result of their lack of knowledge.  For Yahoo shareholders, they do not know how the Yahoo management team will perform (both on the strategy and execution side), so they should logically agree to the hostile offering (based upon the risk of management's failure).  This way, they will receive a good return will an extremely low risk of loss.