An American Depository Receipt (ADR) is a negotiable certificate issued by a U.S. financial institution, typically a bank, that represents a specified number of shares of a foreign company's stock. It allows shares of foreign companies to trade on U.S. stock exchanges as if they were domestic shares. ADRs fall under the broader category of International Investing and provide U.S. investors with a convenient way to invest in overseas companies without directly navigating foreign markets or currencies. Each American Depository Receipt is denominated in U.S. dollars, and any dividends paid by the underlying foreign stock are also converted into U.S. dollars.26, 27
History and Origin
The concept of the American Depository Receipt was pioneered in 1927 by J.P. Morgan, a prominent U.S. financial institution. The very first ADR was issued for the British retailer Selfridges, enabling American investors to directly purchase shares of the company on U.S. exchanges.24, 25 This innovation helped Selfridges access the burgeoning U.S. capital markets and provided a simplified avenue for U.S. investors to participate in global growth. The creation of the ADR addressed the complexities of cross-border transactions, such as currency conversion, foreign regulations, and differing settlement systems, paving the way for increased international investment.22, 23
Key Takeaways
- An American Depository Receipt is a certificate representing shares of a non-U.S. company, allowing them to trade on U.S. stock exchanges.
- ADRs are denominated in U.S. dollars, simplifying pricing and dividend payments for U.S. investors.
- They provide a convenient and accessible way for U.S. investors to gain exposure to international markets.21
- ADRs eliminate the need for investors to directly engage in foreign currency transactions or navigate overseas stock market regulations.20
- There are different types of ADR programs, with varying levels of regulatory compliance requirements from the U.S. Securities and Exchange Commission (SEC).
Interpreting the American Depository Receipt
An American Depository Receipt essentially acts as a bridge between foreign companies and U.S. investors. When interpreting an ADR, investors consider its ratio to the underlying foreign shares. For instance, one ADR might represent one, multiple, or even a fraction of a single share of the foreign company.19 This ratio is determined to ensure the ADR's price is suitable for trading on U.S. exchanges. The price of an American Depository Receipt generally tracks the price of the foreign security in its home market, adjusted for the ratio and exchange rates.18 Understanding the specific ADR program (e.g., Level I, Level II, or Level III) is crucial, as it indicates the level of SEC reporting and visibility the foreign company is willing to undertake, which can affect its liquidity and trading characteristics.
Hypothetical Example
Imagine an American investor, Sarah, wants to invest in "GlobalTech," a popular technology company based in Japan. Directly purchasing GlobalTech equity securities on the Tokyo Stock Exchange would involve opening an international brokerage account, converting U.S. dollars to Japanese Yen, and dealing with Japanese market regulations and trading hours.
Instead, Sarah finds that GlobalTech has an American Depository Receipt program trading on the Nasdaq. A U.S. custodial bank issues the ADRs, with each ADR representing 5 shares of GlobalTech's common stock in Japan. If GlobalTech's shares trade at ¥1,000 each in Tokyo and the exchange rate is ¥150 to $1, then the equivalent value of 5 shares would be ¥5,000, or approximately $33.33. The ADR would then trade around this price on the Nasdaq, allowing Sarah to buy shares of GlobalTech in U.S. dollars through her regular brokerage account, just like any other U.S. stock. When GlobalTech pays dividends, the custodial bank receives them in yen, converts them to dollars, and distributes them to Sarah, net of any fees and foreign taxes.
Practical Applications
American Depository Receipts are widely used to facilitate cross-border investment and capital raising. For U.S. investors, ADRs provide a convenient avenue for diversification by enabling access to a broad range of foreign companies across various industries and geographies without the complexities of direct international trading. Fo17reign companies, in turn, utilize ADR programs to tap into the vast and liquid U.S. capital markets, increase their global visibility, and broaden their investor base. This can make it easier for them to raise capital for expansion and operations. The Federal Reserve has noted that depositary receipts play a significant role in enabling foreign corporations to access U.S. financial resources.
#13, 14, 15, 16# Limitations and Criticisms
Despite their advantages, American Depository Receipts come with certain limitations and potential drawbacks. Investors holding ADRs are still exposed to the underlying risks of the foreign company, including its financial health, political instability in its home country, and exchange rate fluctuations between the local currency and the U.S. dollar. Wh12ile the ADR itself trades in U.S. dollars, the value of the underlying foreign shares can still be impacted by currency movements, affecting the ADR's value.
A11dditionally, ADRs may involve certain fees, such as custodial fees charged by the depositary bank for services like holding the foreign shares and processing dividends. So10me unsponsored ADRs, initiated by broker-dealers without the direct involvement or permission of the foreign company, may offer less transparency or corporate governance oversight. Geopolitical tensions can also pose a risk. For example, some Chinese companies' ADRs have faced potential delisting from U.S. exchanges due to audit inspection disputes and broader political considerations, highlighting the regulatory and political risks associated with cross-border listings.
#7, 8, 9# American Depository Receipt vs. Global Depository Receipt
While often discussed together, the American Depository Receipt (ADR) and the Global Depository Receipt (GDR) serve distinct markets. The key difference lies in where they are traded and their target investor base. An ADR is specifically issued by a U.S. bank and designed to be traded on U.S. stock exchanges, primarily for U.S. investors. In contrast, a GDR is typically issued by an international depositary bank and is traded on multiple international markets, most commonly European exchanges like the London Stock Exchange. While both are negotiable certificates representing foreign company shares, GDRs offer broader global accessibility, allowing foreign companies to raise capital from an even wider pool of investors across different jurisdictions. Both instruments aim to simplify cross-border investment by bypassing the complexities of direct foreign stock ownership.
FAQs
What is the purpose of an American Depository Receipt?
The primary purpose of an American Depository Receipt is to enable U.S. investors to invest in foreign companies without directly dealing with foreign stock exchanges, currencies, or regulatory hurdles. It simplifies cross-border investment and allows foreign companies to access the U.S. capital markets.
5, 6Are American Depository Receipts the same as direct foreign stock?
No, an American Depository Receipt is not the actual foreign stock itself. It is a certificate issued by a U.S. bank that represents ownership of shares in a foreign company, which are held by the bank. This structure allows the ADR to trade on U.S. exchanges like a domestic stock, though its value is still tied to the underlying foreign shares and their local market performance.
4How do ADRs pay dividends?
When the foreign company pays dividends on its underlying shares, the custodial bank holding those shares receives the dividends in the local currency. The bank then converts these dividends into U.S. dollars and distributes them to the American Depository Receipt holders, typically after deducting any applicable fees and foreign taxes.
3Are all foreign companies able to issue ADRs?
No, not all foreign companies issue ADRs. The decision to issue an American Depository Receipt often depends on the company's desire to access U.S. markets, its ability to meet certain U.S. regulatory requirements (which vary by ADR program level), and its strategic objectives for investor reach and trading volume.
What are the different types of ADR programs?
American Depository Receipts generally come in three main "levels": Level I, Level II, and Level III. Level I ADRs are the most basic, traded over-the-counter (OTC), and have minimal SEC reporting requirements. Level II ADRs are listed on a U.S. exchange (like NYSE or Nasdaq) and require more stringent SEC reporting. Level III ADRs also trade on exchanges and allow the foreign company to raise new capital in the U.S. market through a public offering, necessitating the highest level of SEC compliance.1, 2