In for the Long Haul

THE COLONY, TEXAS -- In the fall of 2002, Mark Schwarz began a protracted effort to become a major catalyst for change at Pizza Inn Inc. -- and make some sweeping shifts in corporate governance.

Newcastle Partners, the Dallas-based hedge fund that he runs and now the restaurant chain's biggest shareholder, snared board seats for him and an associate later that year.

Then, following a 2004 proxy battle, the 44-year-old Mr. Schwarz succeeded the departed chairman. He pushed fellow board members to fire Chief Executive Ronnie Parker, beef up recruitment of independent members, switch to an annual election of directors and start holding regular executive sessions without management.

Activist investors like Mr. Schwarz are a burgeoning breed. They're revamping governance and executive-pay practices at companies big and small by doing more than winning or merely threatening proxy fights. They are actually sticking around to make sure improvements happen. That's a change from the so-called corporate raiders of the past decades, who often wanted to break up a business or simply be paid off to go away.

Many institutional holders now prefer activists who "roll up their sleeves and get involved" in fixing corporate underperformers through board seats because a directorship means "you've made a commitment of time and resources,'' says Patrick McGurn, an executive vice president of Institutional Shareholder Services, a proxy-advisory firm in Rockville, Md.

But dissident investors' enlarged boardroom presence doesn't always guarantee better times. At Pizza Inn, for instance, the high cost of its legal battles with several former executives, including Mr. Parker, has battered profits. And Mr. Schwarz himself has attracted considerable controversy there.

"People sitting in boardrooms threatened by these activists will tend to put a black hat on them," says Mr. McGurn, who was speaking generally and isn't familiar with the Pizza Inn case.

Short-Lived Success

For many activist shareholders, getting new blood on the board is the easy part. Mr. Schwarz has learned that lesson during his effort to shake up Pizza Inn, which he contends long suffered from "excessive, irresponsible and inappropriate behavior."

Once the nation's second-biggest pizza chain, the debt-laden company filed for bankruptcy-court protection in 1989. C. Jeffrey Rogers, who had revived USA Cafes' Bonanza steakhouse unit, was hired the following year and given a stash of nearly worthless shares to liquidate the assets of Pizza Inn, whose headquarters occupies an 11-acre campus here in this Dallas suburb. Instead, the new CEO saw potential growth in franchises rather than company-owned restaurants. He and Mr. Parker, a Bonanza colleague he recruited as his second in command in 1992, won kudos for their sizzling turnaround.

The good times, however, didn't last. In August 2002, Pizza Inn directors pushed out Mr. Rogers because he couldn't repay $1.9 million borrowed to buy more shares.

Mr. Rogers says he was "the victim of [Mr.] Parker and others hatching a plot to toss me out and use the company for personal gain."

Mr. Parker, who succeeded Mr. Rogers as CEO, says such accusations are "preposterous" because he and his longtime boss "were very close friends."

Mr. Rogers soon agreed to sell nearly all of his huge Pizza Inn holdings to Newcastle Partners. That sale swelled the hedge fund's stake in Pizza Inn to 32.5%. And as Pizza Inn's biggest investor, Mr. Schwarz, the hedge fund's chief, hoped to join the board.

"I want to help you do the right things," he remembers telling directors. But they refused to commit before a December 2002 annual meeting, he adds.

"Everyone knew Mr. Schwarz was in the midst of a hostile takeover of the company," says F. Jay Taylor, a retired president of Louisiana Tech University who was a Pizza Inn director at the time.

Holding Out

Thanks to an ingenious tactic, Mr. Schwarz prevailed. He threw the annual shareholders meeting into disarray by refusing to cast his votes or attend. "It may be the only time anyone has gotten a board seat doing that," he says. The board hastily agreed to appoint him and another Newcastle official as directors. So with a quorum restored, stockholders convened -- three hours late.

Once on board, however, Mr. Schwarz encountered some difficulties in shaking things up. Two days before the December annual meeting, Mr. Parker and three senior executives had signed juicy deals to shield them from Newcastle, but stockholders weren't told at the meeting.

Along with other goodies in the revised or new contracts, Pizza Inn would pay the executives a total of about $7.4 million if the company changed hands or they quit for minor reasons. Mr. Parker would receive a whopping four times his highest salary plus bonus, far above typical exit packages at bigger businesses. These golden parachutes represented more than twice the company's fiscal 2003 earnings -- and could potentially force Pizza Inn into bankruptcy again.

B. Keith Clark, Pizza Inn's general counsel at the time, was one of the other executives who received the rich deal. His lawyer, Alan L. Busch, says Mr. Clark prepared the accords for himself and fellow officers "to be well paid and secure" after he consulted the company's primary law firm, Akin Gump Strauss Hauer & Feld, which also was Mr. Clark's prior employer.

"The board felt it owed senior management some protection, and that's what resulted," Mr. Taylor says. Mr. Parker says his revised pact, negotiated for months, included trade-offs such as a monetary cap on guaranteed benefits.

But Ramon Phillips, a Pizza Inn director and former executive, says he received the accords the night before the board approved them and lacked time to fully weigh their financial impact. He adds that as far as he can recall, the full board never previously discussed "putting in grandiose golden parachutes."

Mr. Schwarz says he learned about the pacts only from a February 2003 regulatory filing. "It was totally incredible," he says. "There was no accountability." But he says his objections fell on deaf ears.

New Members Wanted

That summer, Mr. Schwarz decided the seven-member board, which lacked a nominating committee before 2003, needed more new blood. He presented the board with a list of contenders, to no avail.

"Our efforts were met with protestations and excuses," he wrote Steve A. Ungerman, then Pizza Inn's chairman, in a letter.

Mr. Ungerman faulted Mr. Schwarz for presenting his 18 prospects just a day before the board's October 2003 meeting. "Attached to the list were everything from résumés to merely one sentence on individual candidates, some of whom you admitted you had never spoken to or met with," Mr. Ungerman chided him in his reply. Mr. Schwarz says he met or spoke with all but one prospect, a former boss of Mr. Parker.

So Mr. Schwarz launched a proxy battle, resulting in the election of two Newcastle candidates to the board in February 2004. One was Mr. Phillips, who had relinquished his board seat in late 2002 after reluctantly supporting the pacts.

But because Mr. Phillips had previously been on the board and for other related reasons, a board legal adviser concluded the proxy contest didn't result in a change of control -- and, therefore, the golden parachutes for Mr. Parker and the others weren't triggered.

Then, anticipating that Mr. Clark would file a severance claim after he resigned in July 2004, Pizza Inn took the pre-emptive measure of going to arbitration.

Mr. Schwarz stated in a subsequent deposition that during a phone conversation on Mr. Clark's last day, he tried "to shake me down and get me to pay him a bunch of money so he would go away quietly. He says, 'You can call it a consulting agreement and...I will agree that there was no change of control.' "

Mr. Busch, the lawyer representing Mr. Clark, says the alleged shakedown "is a projection of Mark Schwarz's own malicious mind-set" because Mr. Clark merely "wants his contract to be honored."

Lawsuit and Termination

With Mr. Clark's possibly costly exit hanging over their heads, the board decided to launch a probe that summer into the company's management-compensation practices.

The result: Last October, Pizza Inn sued Akin Gump in state district court in Dallas for alleged breach of fiduciary duties. It claims the law firm "knowingly exposed Pizza Inn to financial risk" by drafting parachutes that would "enrich and entrench" officers.

In a statement, Akin Gump says, "Pizza Inn's legal theory in this case -- that a company can sue its lawyers for the business decisions made by the company and its board of directors -- is unprecedented under the law, and has no merit." The suit is still pending.

Next, the board's pay panel, comprised of Schwarz allies, attacked Mr. Parker to a degree rarely seen in corporate America.

In Pizza Inn's proxy statement last November, the committee criticized Mr. Parker's guaranteed salary and bonus of at least $825,000 a year. Total remuneration is "well in excess of the compensation of chief executive officers at comparable companies and based upon the company's performance for the last completed fiscal year," the proxy said. It urged closer ties between pay and performance.

Unhappy Holiday

The day before Thanksgiving, Messrs. Schwarz and Phillips personally informed Mr. Parker that the board intended to fire him for cause. The termination notice, which took effect Dec. 13, accused Mr. Parker of "intentional acts of fraud" as part of his and others' efforts to enrich themselves at company and shareholder expense. Directors used similar language the following day, when they added him to the Akin Gump lawsuit.

Mr. Parker says he never "abused one penny of the company's money" and says he commanded Pizza Inn very well. Getting fired "has been harder than I ever dreamed,'' says the 55-year-old unemployed executive, his voice breaking. "This company was my second family -- sometimes to the detriment of my own family and four kids."

The board dropped Mr. Parker from the Akin Gump suit last winter, submitting his dismissal challenge and $4.4 million-plus severance demands to arbitration. An arbitrator is expected to hold a hearing next April.

After Mr. Parker's departure, Pizza Inn limped along under sagging results and two interim leaders until last spring, when a recruiter helped Mr. Schwarz find a permanent CEO: Timothy Taft.

Mr. Taft -- who previously made more than $800,000 annually as president of Whataburger Inc., a private chain -- says he decided to work for $1 this year after he met numerous franchisees upset over Mr. Parker's hefty pay and distracting feud with Mr. Schwarz.

Colleagues hung Mr. Taft's unendorsed $1 check in his corner office. "They're going to put up a sign next to it that says, 'In case of emergency, break glass,' " Mr. Taft quips. His salary will climb to $300,000 in 2006. But "if I don't do a good job in year one," he cautions, "there may not be a year two."

Falling Dough

Fixing Pizza Inn won't be easy. Net income for the chain, which currently has about 400 restaurants, plunged almost 91% to $204,000 for the year ended June 26, amid a roughly $1.45 million increase in legal fees.

Mr. Clark has withdrawn an initial offer to resolve his spat for about $12,500 in unpaid bonus plus legal fees. Mr. Schwarz rejected a mediator's proposal before arbitration began that Pizza Inn settle with Mr. Parker by paying him $1.9 million.

Meanwhile, the war of words persists. The Parker camp contends Mr. Schwarz championed the former CEO's downfall to foster an undeserved image as a white knight of good governance. "We're talking about Mark Schwarz blowing Mark Schwarz's horn," Mr. Parker says. "He's very good at it."

Mounting legal bills and personal attacks don't seem to bother Mr. Schwarz, currently a director at seven public companies.

"If the bad guys win because you're unable to fight for what's right," he asks, "what kind of world will we live in?"

Write to Joann S. Lublin at joann.lublin@wsj.com