A chip disposition criterion is used to decide whether to accept or discard a chip during chip testing. Its quality directly impacts both yield and product quality loss (PQL). The importance becomes even more significant with the increasingly large process variation. For the first time, this paper rigorously formulates the optimal chip disposition problem, and proposes an elegant solution. We show that the optimal chip disposition criterion is different from the existing industry practice. Our solution can find the optimal disposition criterion efficiently with better yield under the same PQL constraint, or lower PQL under the same yield constraint. © 2011 IEEE.