(Reuters) - Microsoft Corp and Yahoo Inc inked a 10-year Web search deal to better compete against market leader Google Inc but stopped short of combining their display advertising businesses.

Shares of Yahoo, which had risen in recent weeks in anticipation of this deal, fell more than 7 percent in premarket trading, while shares of Microsoft edged higher.

The deal will boost Yahoo's annual operating income by about $500 million and yield capital expenditure savings of $200 million, the companies said in a joint statement on Wednesday.

Microsoft's Bing search engine will be the exclusive algorithmic search and paid search technology for Yahoo's sites, while Yahoo will be responsible for selling premium search ads for both companies.

Each company will maintain its own separate display advertising business and sales force, they said.

The deal combines the number two and number three players in the U.S. market for Internet search and positions them to better compete with Google, which has an estimated 65 percent share of the U.S. search market.

(Reporting by Tiffany Wu; Editing by Derek Caney)