Yahoo's directors were in discussions late on Sunday about Microsoft's latest gambit in its unsolicited takeover approach, amid signs that the embattled internet company was preparing to dig in deeper against its suitor.

"The offer still undervalues us," said one person close to Yahoo, after Microsoft hinted that it might reduce its original offer if Yahoo continued to turn its back on negotiations.

The weekend discussions at Yahoo were called hurriedly to consider a response to a letter from Steve Ballmer, Microsoft's chief executive, which was made public on Saturday.

The letter, which amounts to Microsoft's first official statement since it disclosed its bid more than two months ago, signalled the software company's impatience at the lack of any headway and its attempt to turn up the heat on Yahoo's board.

Mr Ballmer promised an all-out takeover battle before the end of the month and hinted that Microsoft would cut the value of its offer if negotiations did not start soon. "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," he wrote.

A person close to Microsoft refused to confirm this meant it would cut the value of its offer but called Mr Ballmer's letter "self-explanatory".

The value of Microsoft's cash-and-stock bid has slipped from its original $31 a share as the software company's own stock has fallen, taking it to $29.36 a share at Friday's close, or about $42bn.

The decline gave Yahoo even less reason to change its stance, the person close to Yahoo said.

Speculation has been rife on Wall Street and in Silicon Valley that Microsoft would eventually sweeten its bid for Yahoo, at least taking it back to the original $31 and potentially lifting it higher in return for a negotiated deal.

In hostile takeover fights in the US, threats to cut the value of a bid are not unusual and are sometimes followed by eventual increases. Larry Ellison, chief executive officer of Oracle (NASDAQ: ORCL - News) , has used the tactic in his own hostile deals, threatening to reduce his offer for BEA Systems (NASDAQ: BEAS - News) last year and actually reducing his bid for PeopleSoft (NASDAQ: PSFT - News) before eventually paying a higher premium for both companies.

In his letter, Mr Ballmer argued that in the two months since Microsoft first revealed its bid, "the public equity markets and overall economic conditions have weakened considerably, both in general and for other internet-focused companies in particular".

At the same time, public indicators suggest that Yahoo's search and page view shares have declined. Finally, you have adopted new plans at the company that have made any change of control more costly."

In one sign of Wall Street's growing concern about the state of the internet advertising market on which Yahoo depends, shares in rival Google have fallen by 16 per cent over the past two months.

Yahoo will make another attempt to paint Microsoft's unsolicited takeover offer as inadequate on Monday as it unveils AMP, a new system that will give online publishers an automated way to place advertisements on each others' sites.