According to William Madison's bio of Kahn, it was not initiated by her. She did not want to leave, if only because she needed the money. The money she agreed to take in exchange for leaving was, according to the book, considerably less than she would have made if she had played out her contract.
She may have wanted to have Judy Kaye play two performances a week, but (again, according to the Madison book) she did not want to leave.
I have heard that even though Prince has told that story, the person it really happened with was Ruth Mitchell.