American Depository Receipts
American Depository Receipts (ADRs) offer an easier approach to international investment. An ADR is a certificate issued by a U.S. bank for the purpose of trading equity shares of a foreign-based corporation in the U.S. stock market. Created in 1927 by J.P. Morgan, ADRs are a convenient way to avoid many of the costs and inconveniences associated with currency exchange rates, foreign regulations, commissions, and other transaction costs. They permit American investors to buy and sell foreign securities within the safety of the U.S. stock markets.
Here’s how they work. A bank in the U.S. purchases the issuing company’s shares in the issuer’s home country. This U.S. bank is called the depository bank. The depository bank deposits the purchased shares in a bank located in the issuer’s country, called the custodian bank. The custodian bank is usually a branch of the U.S. depository bank. The depository bank then issues ADRs, which represent the shares held in the custodian bank, and sells them in U.S. markets.
An ADR certificate may represent more or less than a single share of the underlying stock. If the stock is expensive, the depository bank may wish to make the price of its ADR comparable to similar stocks on American exchanges. In this case, one ADR may represent a fraction of a share of the stock. Likewise, if the stock is cheap, one ADR might represent several shares of the issuer’s stock. ADR shares held in the custodian bank are called American Depository Shares (ADSs).
The price of ADRs in the secondary market fluctuates like other stocks with supply and demand, but the depository bank will not let it deviate much from the price of the underlying stock. If the ADR is trading higher than shares in the domestic market, the depository bank will buy the cheaper foreign shares to hold in the custodian bank and issue more ADRs in the U.S. If the ADR is trading lower, the bank will buy back ADRs and sell sh