(Reuters) - The public battle between J.C. Penney Co (JCP.N) and leading shareholder Bill Ackman escalated Friday with the hedge fund manager demanding the ouster of the retailer's chairman as well as the interim CEO, while Starbucks (SBUX.O) CEO Howard Schultz joined the fray urging the billionaire's removal from the board.
Ackman sent an open letter to the Penney board -- his second letter in as many days -- publicly criticizing the board and seeking the ouster of Chairman Thomas Engibous. A day earlier he had demanded the replacement of interim chief executive Myron Ullman.
"I have lost confidence in our chairman's ability to oversee this board," Ackman said in an open three-page letter.
"Penney is at a very critical stage in its history and its very existence is at risk. In recent weeks, our board has ceased to function effectively."
Late Friday, hedge fund Perry Capital, which owns 7.3 percent of Penney, expressed support for Ackman's strategy and urged the company to immediately seek to replace Ullman with Allen Questrom and Engibous with Ken Hicks. Together Ackman and Richard Perry own almost a quarter of the $3 billion-company.
Perry, head of Perry Capital, said Friday that while his firm appreciates Ullman's willingness to take on the interim CEO role at a "critical juncture," it is necessary that J.C. Penney change its board and management structure in a way that provides the company with "the greatest chance for success."
J.C. Penney fired back, calling Ackman's statements "misleading, inaccurate and counterproductive."
"The board ... is following proper governance procedures, and members of the board have been fully informed and are making decisions as a group. This includes the CEO search process, which is being conducted at an appropriate pace," said Engibous, in a statement.
Schultz said Ackman has damaged the company and believes he should be removed from the retailer's board.
"If I was sitting on that board, I would be asking for Bill Ackman's removal," Schulz told cable television network CNBC. Ullman sits on the Starbucks board.
Courts in Delaware, which govern the board of JC Penney, will only remove directors for the most extreme behavior, such as proof they have been looting a company, said Larry Hamermesh, a professor at Widener University School of Law in Wilmington, Delaware.
"The more likely thing is not removing Ackman, because they can't, but more likely they will find ways to structure board procedures that freeze him out, like appointing a committee of everyone else but him and have it manage everything," said Hamermesh.
He said the board of HealthSouth adopted similar tactics after the company's chief executive, Richard Scrushy, was convicted of bribery but remained a member of the company's board.
The public spat stunned even Wall Street.
"In all my years covering the market, I have never seen anything quite like this situation," said Rick Snyder, analyst with Maxim Group. "It comes down to three things: cash flow, cash flow, cash flow. All the rest of this is just noise," he said. "The only strategy to have in this situation is to have no expectations."
The latest volley began on Thursday when Ackman pushed to more quickly replace Ullman, who was brought back in April to stem sales declines blamed on Ron Johnson, Ackman's pick to turn around the struggling century-old department store chain.
In a letter on Friday, Ackman said the board is not getting material information and does not have access to independent advice.
He also said the board was not being consulted on material personnel decisions, noting that he had learned of the hiring of Debra Berman as senior vice president of marketing from a press release.
Penney shares fell 5.8 percent to $12.87 on the New York Stock Exchange on Friday after having risen 6.7 percent on Thursday.
The pressure comes at a bad time for Penney, which is preparing for the year-end holidays, the biggest selling season of the year.
In an earlier letter made public on Thursday, Ackman, the hedge fund manager behind Pershing Square Capital Management, expressed frustration at the slow pace of the CEO search and pushed the company to name one in 30 to 45 days.
He also said that Questrom, a former Penney CEO, would return as chairman if a CEO he liked was chosen. In an interview on Thursday on CNBC, Questrom said there were only a few people he thinks would be qualified for the CEO job.
Engibous became chairman in January 2012. He was named to the board in 1999. He is the retired chairman of Texas Instruments (TXN.O) and served as its CEO from 1996 through 2004.
Perry said, in a 13D filing with the Securities and Exchange Commission, that the decline in J.C. Penney's stock and bond prices shows that investors have been losing confidence in the company, and added that the market reaction is "particularly alarming" given the five-year $2.25 billion financing package the company recently arranged to shore up its liquidity.
Shares of J.C. Penney are down more than 34 percent this year. A spokesman for Perry Capital was not available for further comment Friday.
Hicks has been the chief executive at Foot Locker since 2009. He has served as the president and chief merchandising officer of Penney in the past.
Pershing Square owned nearly 18 percent of J.C. Penney as of March 31.
"The board shouldn't feel that they've got to act with a gun to their head in picking the CEO of a big business in a time of crisis. They've got to be able to take the time to make an informed decision," said Michael Peregrine, a partner at law firm McDermott Will & Emery who focuses on corporate governance issues.
Penney's credit default swaps also widened on Friday, in a sign that the market believes the chance of a default has increased.
Additional reporting by Dhanya Skariachan and Madeline Will in New York and Lisa Baertlein in Los Angeles and Tom Hals in Delaware; Editing by Lisa Von Ahn, Chris Reese and Bob Burgdorfer