An American Depository Receipt (ADR) is a U.S. dollar-denominated negotiable certificate that represents shares listed on an overseas stock exchange that is traded in the United States. ADRs are issued in the United States by a depository bank that owns the underlying foreign shares and holds them in custody in their country of origin. The issuing bank establishes a ratio of ADRs per each foreign share, ranging from a fraction of one foreign share to a multiple. The price of an ADR reflects the price of the underlying foreign stock adjusted for the exchange rate and the set ratio of ADRs per foreign share. Dividends on ADRs are paid in U.S. dollars. The first ADR was issued in 1927 by J. P. Morgan to allow American investors to invest in United Kingdom shares that were required to remain physically in the country. Subsequently their use has grown dramatically to include Global Depository Receipts (GDRs) that trade in two or more countries outside the issuer’s home market. In 2008 there were more than 2,000 depository receipt programs totaling $1.5 trillion in market capitalization.
International diversification and the prospect of higher returns drive U.S. investor interest in foreign shares. ADRs provide a more convenient and less costly means to invest abroad than buying directly in foreign markets, especially for the retail investor. The U.S. investor relies on the depository bank to handle overseas trading and account settlement as well as foreign currency conversion into U.S. dollars, as the U.S. investor in ADRs is exposed to exchange rate risk. Another possible benefit to investors is greater legal protection with securities issued and traded in the United States.
For overseas issuers, ADRs provide effective access to U.S. equity markets, the largest in the world. They increase and diversify the issuer’s shareholder base and expand the market for its shares. Several recent studies conclude that cross-listing in the United States increases the liquidity of the issuer’s shares. Trading of a foreign corporation’s shares in the United States can also increase international awareness of the firm’s name. Beyond these benefits, some types of ADRs also allow issuers to raise capital in the United States.
There are several types of ADRs that are distinguishable by their intent, whether solely to expand trading in a firm’s shares or to raise capital, and the exchange listing and U.S. Securities and Exchange Commission (SEC) compliance requirements. Level I ADRs are the most basic type. They permit a foreign issuer to have its shares traded in the United States. However, they are not listed on a U.S. exchange and, as a result, need not comply with the reporting standards of an exchange. They trade in the Overthe-Counter (OTC) market via the OTC Bulletin Board or Pink Sheets. They have the least rigorous reporting requirements from the SEC. Their intent is to increase the market for the issuer’s shares in the United States. Level II ADRs are listed on a U.S. national exchange, such as the New York Stock Exchange, American Stock Exchange, or NASDAQ, and, thus, are subject to listing requirements of the individual exchange as well as greater SEC compliance requirements. The chief benefit of a Level II program is that listing on a national exchange expands the firm’s coverage and visibility in U.S. equity markets. Finally, in addition to the benefits of a Level II program, Level III ADRs allow a foreign firm to raise capital in the United States by issuing new shares in an initial public offering (IPO), which entails stricter SEC compliance requirements but provides even greater exposure in U.S. capital markets. Rule 144(a) ADRs or restricted ADRs (RADRs) also allow foreign firms to raise capital in the United States through private placements to “qualified institutional buyers” as defined under the SEC’s Rule 144(a). RADRs are less expensive and require less reporting than do Level III ADRs, but they are less liquid than publicly listed shares.
Another distinction between ADRs is between unsponsored and sponsored certificates. The former are issued by the depository bank without the involvement of the overseas issuer. Unsponsored ADRs are restricted to OTC trading and have become increasingly rare.
- Aggarwal et al., “ADR Holdings of U.S. Based Emerging Market Funds,” Journal of Banking and Finance (2007);
- Citigroup, Depository Receipts Information Guide (2005);
- Deutsche Bank AG, Depository Receipts Handbook (2003);
- Knight, “Depository Receipts Show Robust Returns,” Oxford Metrica International Equity Review (2008);
- Solnik and D. McLeavey, International Investments (Pearson Addison Wesley, 2003);
- S. Securities and Exchange Commission, International Investing (2007).
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