What Is an American Depositary Receipt—ADR?

An American depositary receipt (ADR) is a negotiable certificate issued by a U.S. depository bank representing a specified number of shares (even as little as one share) in a foreign company's stock. The ADR trades in the U.S. as any stock would.

ADRs represent a feasible, liquid way for U.S. investors to purchase stock in companies abroad. The foreign firms also benefit from ADRs, as they make it easier to attract American investors—without having to go through the hassle and expense of listing themselves on stock exchanges in the U.S.

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Introduction To American Depository Receipts ADRs

The Basics of an American Depositary Receipt—ADR

ADRs are denominated in U.S. dollars, with the underlying security held by a U.S. financial institution overseas.To offer ADRs, U.S. banks simply purchase shares from the company on a foreign exchange, holds them as inventory, and issues the ADR for trading domestically. ADRs are listed on either the NYSE, AMEX or Nasdaq, but they are also sold over-the-counter (OTC).

An ADR may represent the underlying shares on a one-for-one basis, or it may represent a fraction of a share or multiple shares. The depositary bank sets the ratio of U.S. ADRs per home-country share at a value that appeals to investors. If an ADR’s value is too high, it could deter some investors, but if it is too low, investors may think the underlying securities resemble riskier penny stocks.

ADR holders do not have to transact in foreign currencies, because ADRs trade in U.S. dollars and clear through U.S. settlement systems. The U.S. banks require that the foreign companies provide them with detailed financial information, making it easier for investors to assess the company's financial health compared to a foreign company that only transacts on international exchanges.

Key Takeaways

  • An American depositary receipt (ADR) is a certificate issued by a U.S. bank that represents shares in a foreign stock, used to trade on American stock exchanges.
  • ADRs and their dividends are priced in dollars.
  • ADRs represent an easy, liquid way for U.S. investors to own global stocks.

Types of American Depositary Receipts—ADRs

American depositary receipts come in two basic categories: sponsored and unsponsored.

A sponsored ADR is issued by a bank on behalf of the foreign company; the two enter into a legal arrangement, which usually involves the foreign company paying the costs of issuing the ADR and retaining control over it, and the bank handling the transactional arrangements. Sponsored ADRs fit into one of three categories, called levels; the higher the level, the greater the degree to which the foreign company has to comply with the U.S. Securities and Exchange Commission (SEC) regulations and American accounting procedures.

An unsponsored ADR is issued by a bank without any involvement, participation or even permission by the foreign company whose stock it represents. Theoretically, there could be several unsponsored ADRs for the same foreign company, issued by different U.S. banks (and offering different dividends). With sponsored programs, there is only one ADR, issued by the bank working with the foreign company.

One main practical difference between the two ADRs lies in where they can be purchased: All but the lowest level of sponsored ADRs register with the SEC and trade on major U.S. stock exchanges, while unsponsored ADRs trade solely over-the-counter. Also, unsponsored ADRs never include voting rights.

American Depositary Receipt—ADR Pricing and Costs

An ADR's prices usually parallel those of the company's stock on its home exchange. For example, British Petroleum (BP)'s ADR, which trades on the NYSE, closed at $44.62 on April 17, 2019; since each ADR represents six shares, the actual price per share would be $7.43. In contrast, the company's stock closed at 572 pence per share—about $7.46—on the London Stock Exchange that same day.

Holders of ADRs realize any dividends and capital gains in U.S. dollars. However, dividend payments are net of currency conversion expenses and foreign taxes (which the bank usually automatically withholds). With capital gains, American investors might have to seek a credit from the IRS or a refund from the foreign government to avoid double taxation.

Real World Exampls of ADRs

Since 1988, German car manufacturer Volkswagen AG had traded OTC in the U.S. as a sponsored ADR, using the ticker symbol VLKAY. On Aug. 13, 2018, Volkswagen terminated its program. The very next day, J.P. Morgan established an unsponsored ADR for Volkswagen, to trade as VWAGY. Investors who held the old VLKAY ADRs had the option of cashing out, exchanging the ADRs for actual shares of Volkswagen stock (trading on German exchanges) or exchanging them for the new VWAGY ADRs.

Pros

  • Easy to track and trade

  • Denominated in dollars

  • Available through U.S. brokers

  • Diversify portfolio

Cons

  • Subject to double taxation

  • Limited selection

  • May not be SEC-compliant (unsponsored ADRs)

  • Incur currency conversion fees

History of American Depositary Receipts—ADRs

Before American depositary receipts were introduced in 1927, American investors wanted to purchase shares of a non-U.S. listed company could only do so on international exchanges—an unrealistic option for the average individual back then.

While easier in the contemporary digital age, purchasing shares on international exchanges still has potential drawbacks, particularly currency-exchange issues and regulatory differences. Before investing in an internationally traded company, U.S. investors have to familiarize themselves with the different rules, or they could risk misunderstanding important information, such as the company's financials. They might also need to set up a foreign account, as not all domestic brokers can trade internationally.