What Are Junior Stocks?

Stockholders in a corporation can own either common or preferred stocks. Preferred stockholders have a superior claim to the company's earnings and assets than do common stockholders. If, for example, a corporation makes a distribution of profits to the stockholders, preferred stockholders receive that distribution first and anything left over goes to the common stockholders. Also, preferred stockholders will be the first to receive payment if the corporation is liquidated, while common stockholders must wait.

Junior stock is a form of common stock that corporations can use to allow employees to own stock at a discounted rate. Junior stock typically comes with fewer shareholder rights than regular common stock does. For example, junior stock has fewer rights to dividends and liquidation proceeds, and fewer voting rights in the governance of the corporation.

Corporations can use junior stock as a form of incentive to employees and management. Junior stock is often convertible into common stock if the employees reach goals as defined in the articles of incorporation. If those goals are not reached, the junior stock will not be converted into regular common stock.

Though junior stock was once a popular incentive method, it is not common today. Because those holding junior stock could claim that it was not as valuable as common stock, the question arose as to how to evaluate it for tax purposes. If the IRS deemed it likely that the junior stock would convert to common stock, and therefore become more valuable, it would impose a higher tax burden on its award. Because of this, corporations issuing junior stock often made it more difficult and unlikely for the stock to convert to common stock, and thus it became less of an incentive when offered to employees.