The surprise departure, announced yesterday, comes just two weeks after Yahoo hired former PayPal executive Scott Thompson as its chief executive.
Mr Thompson is the fourth CEO in less than five years to try to turn around Yahoo - a challenge Mr Yang was unable to pull off during his own tumultuous 18-month reign as the company's CEO in 2007 and 2008.
Mr Yang, 43, endorsed Mr Thompson in his resignation from Yahoo's board of directors. He had been on Yahoo's board since the company's 1995 inception.
"My time at Yahoo, from its founding to the present, has encompassed some of the most exciting and rewarding experiences of my life," Mr Yang wrote in a letter to Yahoo chairman Roy Bostock.
"However, the time has come for me to pursue other interests outside of Yahoo."
The letter did not say what Mr Yang plans to do next. He does not need to work, thanks to the fortune he has amassed since he began working on Yahoo in a trailer at Stanford University with fellow graduate student David Filo.
Mr Yang is worth about $1.1bn (£718m), according to Forbes magazine's latest estimates.
He is also stepping down from the boards of China's Alibaba Group and Yahoo Japan. Yahoo is negotiating to sell its stakes in both of the Asian companies as part of its efforts to placate investors. The deal could be worth as much as $17bn (£11bn), but still faces a series of potentially daunting obstacles before it gets done.
Besides surrendering the board seats, Mr Yang is giving up his position as "Chief Yahoo", an honorary title he held as he mingled among workers, while keeping tabs on various company projects.
Mr Thompson could have an easier time overhauling Yahoo without Mr Yang looking over his shoulder and possibly second-guessing his decisions, said BGC Financial analyst Colin Gillis.
"This has the fingerprints of frustration on it," Mr Gillis said. "It's one of those situations where it looks like he is losing the battle to control the company's direction and now he is saying, 'That's it, I'm out'."
Although a popular figure among Yahoo employees, Mr Yang had alienated the company's shareholders by turning down a chance to sellYahoo in its entirety to Microsoft for $47.5bn (£31bn), or $33 per share, in May 2008. Yahoo shares have not topped 20 dollars for more than three years. The stock gained 49 cents to $15.92 in extended trading after Mr Yang's decision was announced.
The slump in Yahoo's stock has diminished Mr Yang's wealth. He still owns a 3.6% stake in the company.
Investor anger over his handling of the Microsoft negotiations led to Mr Yang's resignation as CEO in late 2008 and the hiring of Silicon Valley veteran Carol Bartz to replace him. Ms Bartz and Mr Yang had got to know each other as part of Cisco Systems' board of directors.
After initially hailing Ms Bartz as the solution to Yahoo's problems, Mr Yang and the rest of Yahoo's board sacked her as CEO in September.
Yahoo's revenue has been falling in recent years even as advertisers have poured more money into the internet. Much of the money, though, has been going to internet search leader Google and Facebook's online social network, as Yahoo has fallen further behind in the race to innovate and develop products that attract web traffic.
Despite its struggles, Yahoo remains profitable and still boasts a worldwide audience of 700 million people.
But visitors are not sticking around Yahoo's services as much as they once did, depriving the company of more opportunities to sell ads - the main source of its revenue.
It has been a jarring comedown for Yahoo, which emerged as one of the internet's first stars after Mr Yang and Mr Filo expanded the service beyond its roots as a hand-picked directory of websites.
Yahoo's early success turned it into a Wall Street darling and landed Mr Yang on the covers of leading business magazines. At the height of the dot-com bubble 12 years ago, Yahoo's stock was trading above a split-adjusted 100 dollars amid talk that the company might eventually try to buy a long-established media franchise such as the Walt Disney Company.
But now investors widely regard Yahoo as a misguided company that cannot come up with a cohesive plan to define itself for web surfers and advertisers.
Mr Yang and Mr Bostock have been the focal point for much of the criticism, partly because of their key roles in the Microsoft talks in 2008.
After buying a 5.2% stake in Yahoo last autumn, hedge fund manager Daniel Loeb demanded that both Mr Bostock and Mr Yang step down from the company's board. If they refused, Mr Loeb indicated he would finance a shareholder rebellion to oust both men from the board.
Mr Loeb's fund, Third Point LLC, did not immediately return a phone call for comment.
Mr Bostock, Yahoo's chairman for the past four years, has given no indication that he plans to step down.
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