An American depositary receipt (ADR, and sometimes spelled depository) is a negotiable security that represents securities of a non-U.S. company that trades in the U.S. financial markets.
Shares of many non-U.S. companies trade on U.S. stock exchanges through ADRs, which are denominated and pay dividends in U.S. dollars and may be traded like regular shares of stock. ADRs are also traded during U.S. trading hours, through U.S. broker-dealers. They simplify investing in foreign securities by having the depositary bank “manage all custody, currency and local taxes issues”.
The first ADR was introduced by J.P. Morgan in 1927 for the British retailer Selfridges on the New York Curb Exchange, the American Stock Exchange’s precursor.
They are the domestic equivalent of a global depository receipt (GDR). Securities of a foreign company that are represented by an ADR are called American depositary shares (ADSs).
Rs were introduced as a result of the complexities involved in buying shares in foreign countries and the difficulties associated with trading at different prices and currency values. For this reason, U.S. banks simply purchase a bulk lot of shares from the company, bundle the shares into groups, and reissues them on either the New York Stock Exchange (NYSE), American Stock Exchange (AMEX) or the Nasdaq. In return, the foreign company must provide detailed financial information to the sponsor bank. The depositary bank sets the ratio of U.S. ADRs per home-country share. This ratio can be anything less than or greater than 1. This is done because the banks wish to price an ADR high enough to show substantial value, yet low enough to make it affordable for individual investors. Most investors try to avoid investing in penny stocks, and many would shy away from a company trading for 50 Russian roubles per share, which equates to US$1.50 per share. As a result, the majority of ADRs range between $10 and $100 per share. If, in the home country, the shares were worth considerably less, then each ADR would represent several real shares.
There are three different types of ADR issues:
Level 1 – This is the most basic type of ADR where foreign companies either don’t qualify or don’t wish to have their ADR listed on an exchange. Level 1 ADRs are found on the over-the-counter market and are an easy and inexpensive way to gauge interest for its securities in North America. Level 1 ADRs also have the loosest requirements from the Securities and Exchange Commission (SEC).
Level 2 – This type of ADR is listed on an exchange or quoted on Nasdaq. Level 2 ADRs have slightly more requirements from the SEC, but they also get higher visibility trading volume.
Level 3 – The most prestigious of the three, this is when an issuer floats a public offering of ADRs on a U.S. exchange. Level 3 ADRs are able to raise capital and gain substantial visibility in the U.S. financial markets.
The advantages of ADRs are twofold. For individuals, ADRs are an easy and cost-effective way to buy shares in a foreign company. They save money by reducing administration costs and avoiding foreign taxes on each transaction. Foreign entities like ADRs because they get more U.S. exposure, allowing them to tap into the wealthy North American equities markets.