Fallen Plum

Junior stock grew too ripe

One of the most talked-about new schemes for persuading a prized employee to stay with a company is to lavish on the person something called junior stock. Conceived in 1979 by Genentech, the bioengineering firm, junior stock has been widely used by such firms as Tele-Video Systems and Amdahl, two computer companies, and Cetus, another bioengineering concern. The plan has been particularly popular in California's Silicon Valley, where firms need all the incentives they can find to keep the engineers and scientists from job hopping. Some 200 high-tech firms have either issued junior shares or considered doing so.

Companies typically sell the junior shares to employees at 20% of the price of regular stock. Generally, the shares can be converted to common stock in three to five years if the company meets its goals for profits or sales. Genentech employees, for example, paid an average of $1.62 a share for junior stock that was worth $36.25 the day it became convertible.

The wind, though, is now going out of the windfalls. This week the Financial Accounting Standards Board, a private group that sets rules for corporate bookkeeping, will propose guidelines that would virtually banish junior shares. The F.A.S.B. and the Securities and Exchange Commission believe that junior shares should be considered a form of pay. This would force companies to show on their books the expense of converting employees' low-priced junior stock into more valuable common shares. In some cases, this could reduce profits by as much as 25% after a few years. Said F.A.S.B. Staffer Steven Johnson: "Currently the financial statements don't give an honest view of what happens when the company in effect gives away $40 stock for $5."

The SEC originally allowed Genentech's junior stock because, like other equities, it involved some risk on the employee's part. If the company failed to meet its performance goals, the employee would be forbidden to convert the junior stock to common shares. Thus the worker would make no money on the deal. But some firms set standards so low that their junior-stock plans became giveaways. Admits Palo Alto Attorney Lee Benton, a proponent of the stock: "Some companies took it further than it was ever intended to go."

Junior stock has also been under scrutiny by the Internal Revenue Service, which has yet to decide how the stock will be taxed. Other equities generally fall under the long-term capital-gains rate of 20% or less if they are held longer than one year. The IRS, however, may rule that taxpayers must classify profits from the conversion of junior stock as regular income. This would force shareholders to pay a rate of up to 50%, which would help make junior stock a thing of the past.