Answer: retained earnings.

## Explanation A stock dividend distribution reduces a company's **retained earnings**. **Key points:** - When a company issues a stock dividend, it transfers a portion of retained earnings to paid-in capital (common stock and additional paid-in capital accounts) - This is an accounting transfer within shareholders' equity - from retained earnings to contributed capital - **Total shareholders' equity remains unchanged** - it's just a reclassification within equity accounts - **Financial leverage ratios are not affected** because there is no change in total assets or liabilities - The reduction in retained earnings is exactly offset by an increase in paid-in capital **Example:** If a company issues a 10% stock dividend, retained earnings decrease by the market value of the shares distributed, while common stock and additional paid-in capital increase by the same amount.

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