Which factor can cause Shareholders' Equity to be negative?

Which factor can cause Shareholders' Equity to be negative?

• A. Leveraged Buyouts with dividend recapitalizations
• B. High profits
• C. Increase in Retained Earnings
• D. Issuing new stock

Answer: (B)

Shareholders' Equity can become negative when the equity base is eroded, typically by large distributions funded with debt or by sustained losses that reduce retained earnings below zero. High profits raise retained earnings and thus increase, not decrease, equity, so they won’t cause negative equity. An increase in retained earnings directly boosts the equity portion of the balance sheet. Issuing new stock brings in additional paid-in capital and expands total equity, also preventing negative equity. A leveraged buyout with dividend recapitalizations uses debt to pay sizable dividends, which reduces equity (through lower retained earnings and higher liabilities) and can drive it negative if the decline isn’t offset by profits or asset value.

Shareholders' Equity can become negative when the equity base is eroded, typically by large distributions funded with debt or by sustained losses that reduce retained earnings below zero.

High profits raise retained earnings and thus increase, not decrease, equity, so they won’t cause negative equity. An increase in retained earnings directly boosts the equity portion of the balance sheet. Issuing new stock brings in additional paid-in capital and expands total equity, also preventing negative equity. A leveraged buyout with dividend recapitalizations uses debt to pay sizable dividends, which reduces equity (through lower retained earnings and higher liabilities) and can drive it negative if the decline isn’t offset by profits or asset value.