In the latest issue of Currency, Grant Thornton LLP’s newsletter for community bank executives, the CEO at Royal Bank of Pennsylvania in Narberth says that all his staff members — from tellers on up — are offered stock options within their first year of employment.

“My job,” Joe Campbell tells the quarterly, “is to make the associates owners.”

This approach is used at many smart community banks, but what struck me was that 60% of profits at $650 million-asset Royal Bank are given back to shareholders and personnel through quarterly dividends. This is double the average community bank’s percentage return, Currency says.

Should other banks copy this generous approach to dividends?

Several bankers and analysts warned me that banks should do this only if they can spare the capital. If a bank is overcapitalized, and if management feels that it is in a slow-growth market and it will not need this excess capital, then unloading some capital makes sense. And if the bank wants to lower its capital-to-deposits ratio, the only choices are higher dividend payouts or stock repurchase plans.

Which is the better choice?

From the viewpoint of tax efficiency, the buyback, of course, is the better choice, because the only tax consequences are any capital gains taxes the sellers of the shares would pay. Dividends, however, are subject to normal income taxes.

But many bankers still feel that a more generous payout policy benefits both the bank and its shareholders. First of all, shareholders like solid dividends; that is why they bought the stock in the first place, and they are willing to pay the taxes involved in a dividend hike.

In addition, from a standpoint of loyalty, many CEOs prefer dividend increases to stock buybacks, which reward people who will no longer be part of the bank’s family. Stockholders help form the bank’s business base.

Also, there is no assurance that buybacks will actually raise the stock price. A dividend payout will remain with the shareholder to be spent, but a share-price increase is not guaranteed.

There is one danger to paying higher dividends, though. A bank will make enemies if it increases the dividend and later lowers it as conditions change and the bank can no longer spare the capital. After some banks lowered their dividends during an earnings crunch, their stocks plummeted, and they did not recover for a long time.

One case I remember that was even more drastic. I was on the board of a real estate investment trust whose policy was to raise the monthly dividend 1 cent a month. The first time we could not do this, our stock plunged. The small change in payout policy was seen by the investment community as a sign that we were in trouble. The stock never rebounded.

But if you feel your bank can maintain a consistently higher payout level, it certainly is a win-win situation.

A reporter once asked the head of Union Oil why the company paid out only 10% to 15% of its earnings in dividends. The response: “We do not like to pass out corporate assets to total strangers.”

Your shareholders are not strangers. Serving them better will help your entire organization.

Mr. Nadler, an American Banker contributing editor is a professor of finance at Rutgers University Graduate School of Management in Newark, N.J.

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