Icahn, who has spent billions of dollars in recent months to build up a 5% stake in the company, has been pushing for the complete removal of Yahoo's board. In its place, he wanted to install executives who are open to selling Yahoo to Microsoft, which has failed in several attempts to acquire Yahoo, most recently last week, when it teamed with Icahn to table a bid for Yahoo's search business.
Today's agreement will put Icahn and two of his nominees on an expanded board of Yahoo directors.
The agreement will avert a battle over control of the company that was expected at Yahoo's 1 August shareholder vote.
Under the agreement, eight members of the current board will seek re-election and Icahn will be appointed to the board, with two other seats filled from a list of nine candidates recommended by Icahn.
Yahoo co-founder and chief executive Jerry Yang said: "This agreement will not only allow Yahoo to put the distraction of the proxy contest behind us, it will also allow the company to continue pursuing its strategy of being the starting point for internet users and a must-buy for advertisers."
Icahn said: "While I continue to believe that the sale of the whole company or the sale of its search business in the right transaction must be given full consideration, I share the view that Yahoo's valuable collection of assets positions it well to continue expanding its online leadership and enhancing returns to stockholders."
In recent weeks, Icahn and Yahoo's board have been engaged in a bitter war of words, culminating in an exchange last week (17 July), when Yahoo wrote to shareholders labelling Microsoft's recent takeover attempts "stupefying".
The letter from Yahoo chairman Roy Bostock and chief executive Jerry Yang attacked Icahn, criticising his lack of knowledge about the business.
United Kingdom
Yahoo offers Icahn board seats as olive branch
LONDON - Yahoo has moved to head off a shareholder showdown next month, by handing activist investor Carl Icahn three seats on its board.
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