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What Is American Depositary Share (ADS)?

An American Depositary Share (ADS) is a security that represents shares of a foreign company, allowing these shares to be traded on U.S. stock exchanges. It is a fundamental component within the broader category of investment vehicles. ADSs are issued by a U.S. depositary bank and allow U.S. investors to gain exposure to international companies without the complexities of direct cross-border transactions. The terms American Depositary Share and American Depositary Receipt (ADR) are often used interchangeably by market participants, though technically the ADR is the certificate that evidences ownership of one or more ADSs39, 40.

History and Origin

The concept of American Depositary Shares originated in the 1920s to simplify international investing for U.S. investors. Before their introduction, Americans seeking to invest in foreign companies faced significant hurdles, including dealing with different regulatory environments, trading practices, and currency exchange rates on international exchanges38.

J.P. Morgan's predecessor, Guaranty Trust Company, pioneered the American Depositary Receipt concept. In 1927, J.P. Morgan launched the first ADR for the British retailer Selfridges, enabling U.S. investors to buy shares of the famous department store on the New York Curb Exchange, the precursor to the American Stock Exchange35, 36, 37. This innovation provided a more accessible and convenient way for foreign companies to tap into the U.S. capital markets and for U.S. investors to diversify their portfolios internationally34.

Key Takeaways

  • American Depositary Shares (ADS) provide U.S. investors with an avenue to invest in foreign companies on domestic exchanges.
  • ADSs are denominated in U.S. dollars and typically trade like regular shares of U.S.-based companies, simplifying transactions for investors.
  • The ratio of ADSs to the underlying foreign shares can vary, allowing for a more accessible price point for U.S. investors.
  • ADS programs can be sponsored (with the foreign company's involvement) or unsponsored (without the foreign company's direct involvement), impacting regulatory requirements and information availability.
  • While offering diversification, ADSs carry specific risks, including currency fluctuation and political instability in the foreign company's home country.

Formula and Calculation

While there isn't a specific "formula" for calculating an American Depositary Share in the same way one might calculate a financial ratio, the core concept involves a conversion ratio between the ADS and the underlying ordinary shares.

The depositary bank sets the ratio of ADSs to the home-country shares. This ratio is chosen to make the ADS price appealing to U.S. investors, often aiming for a price range typical of U.S. stocks33. For instance, an ADS might represent a single foreign share, a fraction of a share, or multiple shares32.

For example, if a foreign company's stock trades at $100 per share in its home market and the depositary bank sets a ratio of 1 ADS = 5 foreign shares, the ADS would theoretically trade around $500, excluding fees and market fluctuations. This ratio is crucial for understanding the value of an ADS relative to the underlying security.

Interpreting the American Depositary Share

Interpreting an American Depositary Share primarily involves understanding its relationship to the foreign company's ordinary shares and the implications for a U.S. investor's portfolio. When an investor buys an ADS, they are essentially acquiring an ownership interest in a foreign company, with the shares held by a U.S. depositary bank30, 31.

The price of an ADS generally tracks the price of the foreign security in its home market, adjusted for the ADS-to-share ratio and prevailing exchange rates29. This means that movements in the foreign stock's price and the exchange rate between the U.S. dollar and the foreign currency will directly influence the ADS's value in U.S. dollars. Investors should also consider the different types of ADS programs (Level I, Level II, Level III, and Rule 144A), as these dictate the level of financial disclosure and the exchanges on which the ADSs can trade, impacting the transparency and liquidity of the investment28. A Level III ADS, for instance, requires extensive SEC filings, similar to a domestic company.

Hypothetical Example

Imagine a German automobile manufacturer, "Autobahn AG," wants to make its shares accessible to U.S. investors without directly listing on a U.S. exchange. Autobahn AG partners with a U.S. depositary bank, "AmeriBank," to create an American Depositary Share program.

  1. Deposit of Shares: AmeriBank's custodian in Germany acquires 10,000 ordinary shares of Autobahn AG on the Frankfurt Stock Exchange.
  2. ADS Issuance: AmeriBank then issues 1,000 American Depositary Shares (ADSs) in the U.S., with a ratio of 1 ADS representing 10 ordinary shares of Autobahn AG.
  3. U.S. Trading: A U.S. investor, Sarah, wishes to invest in international automotive companies. Instead of dealing with the Frankfurt Stock Exchange, she purchases 5 ADSs of Autobahn AG through her U.S. brokerage account at a price of $50 per ADS. This means she effectively holds an interest equivalent to 50 ordinary shares (5 ADSs * 10 shares/ADS).
  4. Dividend Payment: If Autobahn AG declares a dividend of €1 per ordinary share, AmeriBank receives the euro-denominated dividends for the deposited shares. AmeriBank then converts these euros to U.S. dollars (less any applicable fees or taxes) and distributes the dollar equivalent to Sarah, who would receive $5 in dividends for her 5 ADSs (assuming no fees and a 1:1 conversion for simplicity, though real-world conversions involve exchange rates). This process simplifies the collection of dividends for U.S. investors.

Practical Applications

American Depositary Shares are primarily used to facilitate international investment and capital raising. For U.S. investors, ADSs offer a simplified way to diversify their holdings globally by investing in foreign companies that do not directly list their shares on U.S. stock exchanges. 26, 27This allows investors to gain exposure to various industries and markets worldwide, contributing to their portfolio diversification strategies.

For foreign companies, establishing an ADS program provides access to the vast U.S. capital markets, enabling them to raise capital, increase their visibility, and attract a broader investor base. 23, 24, 25Major U.S. exchanges like the NYSE and Nasdaq host many foreign companies through their ADS programs, as the U.S. stock market is the largest in the world. 21, 22For example, in 2021, depositary receipt trading volume globally was 299.2 billion shares. 20Citibank and J.P. Morgan are prominent depositary banks that facilitate numerous ADS programs.
17, 18, 19

Limitations and Criticisms

While American Depositary Shares offer significant benefits, they also come with inherent limitations and criticisms. A primary concern for investors is foreign exchange risk. Even though ADSs are denominated and traded in U.S. dollars, the underlying shares are in a foreign currency. Fluctuations in exchange rates between the U.S. dollar and the foreign currency can impact the ADS's value and the U.S. dollar equivalent of any dividends received. 16For instance, if the foreign currency weakens against the U.S. dollar, the value of the ADS may decrease, even if the foreign company's stock price remains stable in its local currency.

Another risk involves the political and economic environment of the foreign company's home country. Political instability, changes in regulations, or economic downturns in the foreign market can directly affect the value of the ADS. 15The transparency and information available for certain ADSs, particularly unsponsored ones, may also be less comprehensive than for U.S. domestic stocks, as foreign companies may not be subject to the same stringent financial reporting requirements of the U.S. Securities and Exchange Commission (SEC).

Recent geopolitical events have also highlighted potential drawbacks. For example, the freezing of Russian assets following the war in Ukraine has created complications for holders of Russian ADSs, with ongoing discussions about compensation and the legal implications of such actions. In 2024, Russia indicated that it hoped a scheme allowing Russians to sell frozen foreign securities to foreigners with frozen assets in Russia would benefit Russian stocks. 13, 14Similarly, the Kremlin stated in April 2024 that any U.S. move to seize frozen Russian assets would be illegal and challenged in court, promising retaliation. 12Such situations underscore the geopolitical risk associated with international investments like ADSs.

Furthermore, depositary banks may charge various fees, including custody fees and fees for processing dividends and corporate actions, which can add to the total investment cost. 11In December 2018, JPMorgan Chase Bank N.A. agreed to pay over $135 million to settle charges by the SEC regarding the improper handling of "pre-released" ADRs, where ADRs were issued without the corresponding foreign shares being held in custody. 10This incident highlighted a practice that inflated the total number of tradeable securities and could lead to abusive practices like inappropriate short selling.

American Depositary Share (ADS) vs. Global Depositary Receipt (GDR)

The terms American Depositary Share (ADS) and Global Depositary Receipt (GDR) both refer to financial instruments that enable investors to trade shares of foreign companies, but they differ primarily in their listing markets and target investors.

An American Depositary Share (ADS) represents the underlying shares of a non-U.S. company, held by a U.S. depositary bank, and is specifically designed to be traded on U.S. stock exchanges, such as the New York Stock Exchange (NYSE) or Nasdaq. ADSs are denominated in U.S. dollars and are primarily marketed to U.S. investors, simplifying their access to international equity markets by adhering to U.S. market conventions and regulatory frameworks.

In contrast, a Global Depositary Receipt (GDR) is a broader type of depositary receipt that represents shares in a foreign company and can be traded in multiple international markets outside of the issuer's home country and the U.S. GDRs are often listed on European exchanges, such as the London Stock Exchange or the Luxembourg Stock Exchange, and can be denominated in various currencies, including U.S. dollars or euros. While ADSs cater specifically to the U.S. market, GDRs aim for a wider global investor base, providing companies with greater flexibility in raising capital from diverse international sources.

FAQs

What is the primary purpose of an American Depositary Share?

The primary purpose of an American Depositary Share (ADS) is to allow U.S. investors to easily invest in shares of foreign companies without the complexities of direct trading on foreign stock exchanges. 8, 9It also enables foreign companies to access the U.S. capital markets.
7

How do I buy American Depositary Shares?

You can buy American Depositary Shares (ADSs) through a U.S. brokerage account, just like you would buy shares of a domestic company. The ADSs trade on U.S. exchanges such as the NYSE or Nasdaq, or over-the-counter (OTC) markets.
6

Are American Depositary Shares the same as direct ownership of foreign stock?

While American Depositary Shares (ADSs) represent an ownership interest in a foreign company, they are not the same as directly owning the foreign company's ordinary shares. The actual foreign shares are held by a U.S. depositary bank or its custodian, and the ADS is a certificate representing that interest. 4, 5Holders of ADSs still receive economic benefits, such as dividends, which are typically converted to U.S. dollars.
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Do American Depositary Shares pay dividends?

Yes, American Depositary Shares (ADSs) can pay dividends. The depositary bank receives the dividends in the foreign currency from the issuing company, converts them into U.S. dollars, and then distributes them to ADS holders, after deducting any applicable fees or taxes.
2

What are the different types of American Depositary Share programs?

American Depositary Share (ADS) programs are generally categorized into sponsored and unsponsored. Sponsored programs involve the foreign company directly working with a depositary bank to issue ADSs and typically come in three levels (Level I, Level II, and Level III) with varying regulatory requirements and trading venues. 1Unsponsored programs are created by financial institutions without the direct involvement or approval of the foreign company.