The internet company Yahoo has settled a lawsuit with a Chinese journalist and dissident who were both sent to prison after the company passed on their details to the government.

Details of the settlement have not been released except for the fact that the US firm will pay the legal fees of the two men, Shi Tao and Wang Xiaoning, and the relative who sued on their behalf. Yahoo also said that it would “provide financial, humanitarian and legal support to these families.”

The climbdown marks a dramatic change of heart from Yahoo, which had always insisted that it had no choice but to comply with a request from Chinese authorities to share information about the online activities of the two Chinese nationals, who are both serving 10-year jail terms.

Its co-operation with the Chinese government had turned into a public relations nightmare that saw the Yahoo! chief executive, Jerry Yang, attacked as morally stunted at a hearing on Capitol Hill last week. “While technologically and financially you are giants, morally you are pygmies,” said Tom Lantos, the Democrat who chairs the House Foreign Affairs Committee.

Alibaba.com, China’s biggest online concern, has run Yahoo’s mainland China operations since Yahoo bought a 40-per cent stake in it two years ago - a stake that is seen as increasingly valuable after Alibaba share's almost tripled on their stock market debut last week. Mr Shi and Mr Wang sued both companies in April.

Yahoo would not say whether its dealings in China or Alibaba’s mode of responding to government requests will change as a result of the settlement, although it says it has no control over Alibaba.

Mr Shi, a former writer for the financial publication Contemporary Business News, was jailed under state secrecy laws for allegedly posting details of a government order forbidding media coverage of the 15th anniversary of the Tiananmen Square uprising. Mr Wang, an engineer. was arrested in 2002 in connection with anonymous e-mails and other political writings he posted online.

At last week's congressional hearing, both Mr Yang and Michael Callahan, the Yahoo general counsel, apologised to Mr Shi’s mother, who sat behind them.

“After meeting with the families, it was clear to me what we had to do to make this right for them, for Yahoo and for the future,” Mr Yang said in a statement last night. "At Yahoo, we believe in the transformative power of the internet - that's why we are so committed to working to support free expression and privacy around the world."

The dissident writers' US lawyer, Morton Sklar, said Yahoo lost its will to fight the lawsuit after being accused of misleading Congress.

“There was a dramatic change in their position and that was strong incentive to settle,” Mr Sklar said. “They did not want to be on the wrong side of this issue.”

Yahoo is far from being the only American internet company facing a quandary over business practices in China and Mr Sklar said that he suspected there were many more dissidents in Chinese jails because of American companies’ co-operation with the Chinese government.

“They will have to recognise they have to do more than just follow the law,” he said. “They can negotiate with the host countries and not be complicit in torture.”

Mr Lantos, the Foreign Affairs Committee chairman, remained scathing despite the settlement. “It took a tongue-lashing from Congress before these high-tech titans did the right thing and coughed up some concrete assistance for the family of a journalist whom Yahoo had helped send to jail,” he said. “What a disgrace.”

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