The letters keep flying back and forth between investor Carl Icahn and Yahoo. On Wednesday, Icahn called for Jerry Yang’s head and characterized its employee retention plan as a “poison pill” intended to kill the Microsoft deal.

On Thursday, Yahoo chairman Roy Bostock responded, saying that Icahn was misrepresenting the facts. (He also denied that Yahoo ever turned down a $40 a share offer back in January 2007).

Icahn, who wants nothing more than to keep this public dialog going, fired back with another letter today, detailing his plan for Yahoo, should his alternative slate of directors take over the board.

If elected, his board would do the following five things (I am paraphrasing here):

1. Remove the “poison pill” retention plan and replace it with one that would be less costly to Microsoft.
2. Fire Jerry Yang.
3. Stop talking to Google, News Corp, Time Warner, or anyone else unless they offer at least $33 a share.
4. Publicly prostrate themselves before Microsoft and beg Steve Ballmer to reconsider buying Yahoo.
5. If that fails, only then maybe do a search deal with Google.

To which Yahoo has already responded: Carl, you are dreaming. See full text of both letters below. Update 6/10/08: Plus, Yahoo’s latest detailed FAQs submitted to the SEC in which it discusses the meaning of the word “nuts”

Carl C. Icahn
ICAHN CAPITAL LP
767 Fifth Avenue, 47th Floor
New York, NY 10153

June 6, 2008

Roy Bostock
Chairman
Yahoo! Inc.
701 First Avenue
Sunnyvale, CA 94089

Dear Roy:
While you may take issue with the content of my letter, I take issue
with your oversight of Yahoo! Again, I stand by my characterization of your
“poison pill” severance plan and I find it humorous to see you attempt to
defend it.

Roy, it is you who “misrepresents and misstates the details” of the
plan. Much like the rhetoric in many well known political campaigns, you
keep repeating misstatements in the hopes that by repeating misstatements
enough times it will convince your shareholders that these misstatements
are valid. For example, you repeated, “the plan was fully disclosed at the
time of its adoption and should be no surprise to anyone at this point.”
This is simply not true. The egregious magnitude of the dollar amount cost
of the plan was never fully disclosed, nor was the email from your
compensation advisor calling the plan “nuts.” While you keep repeating that
the severance plan was in the “best interests of shareholders”, you neglect
to mention that the financial cost of the plan could be immense. The
documents obtained during discovery and released in the shareholder
complaint show that Yahoo! estimates the maximum change in control
severance expenses to be a staggering $2.4 billion if Microsoft bids $35
per share for Yahoo! You neglected to mention that the true cost to an
acquirer may be even higher as the perverse change in control severance
incentives may diminish the work effort of Yahoo! employees. In case you do
not understand the plan, in addition to the $2.4 billion of severance
expenses, I believe the plan will negatively impact employee behavior and
degrade the ability of an acquirer to successfully integrate the
acquisition. In the event of a change of control, the employee may decide
not to work as hard in the hopes of cashing in on a robust severance
package that awards up to two years salary and benefits, $15,000 of
outplacement expenses, and accelerated vesting of stock options and
restricted stock units. To make matters worse, it is not just the acquirer
firing the employee that can trigger the severance package but the employee
who may decide on his or her own to resign for “good reason” at any point
within two years of a change in control. It is quite obvious to me that
this plan impacts the price an acquirer would pay. Is it any wonder than an
acquirer, once fully comprehending this plan, might not wish to negotiate
any further? I again call upon you to honor your fiduciary duty to your
shareholders and rescind this “poison pill” severance plan.

You asked, “what exactly would happen to our Company if you and your
nominees were to take control of Yahoo!” I will give you my perspective on
that.

— First, I would work to have the board replace your “poison pill”
severance plan with an acceptable alternative.

— Second, I intend to ask our new board to hire a talented and
experienced CEO (attempting to replicate Google’s success with Eric
Schmidt) to replace Jerry Yang and return Jerry to his role as “Chief
Yahoo”. Indeed, it was much speculated that Jerry would serve in the
CEO role temporarily until a permanent CEO was hired after the board
asked Terry Semel to resign.

— Third, I intend to ask our new board to inform Microsoft that unless
any alternative transaction can insure a $33 or higher stock price (of
which I am skeptical) all talks of alternative transactions are over.

— Fourth, I will ask our new board to offer publicly to sell Yahoo! to
Microsoft in a friendly and cooperative transaction.

— Fifth, to the extent Microsoft does not want to make a proposal, I will
ask our new board do a deal on search with Google, but only if it
contains termination provisions that would in no way impede a
subsequent acquisition by Microsoft.

Now let me ask you a couple of questions, Roy:

— Why don’t you, now that you have the opportunity, remove the “poison
pill” severance plan that I find to be ridiculous and thereby remove a
major obstacle to a Microsoft acquisition?

— In my opinion, Microsoft does not believe you will ever sell the entire
company on a friendly basis. So why don’t you stop dancing around the
subject and publicly offer to sell the company to Microsoft for $34.375
per share and promise to cooperate completely?

— Why are you still giving hope to Microsoft that there is a possible
“alternative deal”? As long as there is the possibility of an
“alternative deal”, isn’t it obvious that Microsoft will not make a bid
for the whole company?

Sincerely yours,

CARL C. ICAHN

Yahoo’s response:

Leaving aside Mr. Icahn’s inaccurate interpretation of our retention plan, we again note that he has no credible plan to operate Yahoo!. We believe that Mr. Icahn’s suggestion that we cancel our retention plan would have a destabilizing impact on Yahoo! and would clearly not be in the best interests of our shareholders. Furthermore, his suggestion that we put out a price publicly to see if Microsoft will alter its stated position is ill-advised. As we have stated numerous times publicly and privately, we are open to any transaction including a sale to Microsoft if it is in the best interests of shareholders.

Update: Yahoo turned in a list of FAQs to he SEC to address questions about its retention plan, including whether or not it is “nuts.”. Excerpt:

Did Yahoo!’s compensation consultant say that the Plan is “nuts”?
No. As indicated above, estimating the cost of the Plan requires making a number of assumptions. Timothy J. Sparks, the president of Compensia, Yahoo!’s compensation consultant firm, explained in a sworn deposition that he used the word “nuts” to describe his opinion of using the assumption that 100 percent of Yahoo!’s employees would actually receive the severance benefits under the Plan to determine cost estimates. Mr. Sparks made clear in his deposition that his remark did not relate to the design or cost of the Plan.

(Photo by Sam Lustgarten).