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American Depositary Receipts – Definition

American Depositary Receipt (ADR) Definition

The ADR (American Depositary Receipt) Shares are the securities representing the ownership of non-US shares deposited in US banks.

A Little More on What is an American Depository Receipt

The ADR Shares let US investors purchase the shares of foreign businesses from their own market in US dollars. In turn, businesses from the non-US countries get a way to enhance their funding by bidding on the American stock market. Like an ordinary shares, ADR Shares bear a proportional percentage of the company’s capital stock. Moreover, they grant the same rights to the investors. Among others:

However, the ADR action may not always be equal to ADS. They may reflect both packages of the shares and their divisions. Moreover, the ADR Shares are listed and traded in US dollars. The same price is used for listing as the translated ADSs per currency. Hence, the figure for the financial arbitration can be provided. In fact, as the American stock market closes afterwards, based on the market we compare with, the original shares’ closing values are generally taken as reference.

The ADR operations can be summarized in the following steps:

  1.    A foreign company enters the US market with its shares.
  2.    An American placement agent makes a contract with the company to guarantee a subscription of the shares (that is called the underwriting contract).
  3.    A US bank (depository) will protect and issue ADRs.

This way, the US investors can get shares of the foreign businesses without being worried for the exchange rate, the language of the market or the fiscal repercussions.

However, ADRs are generally linked to  different commissions (currency exchange, custody, etc.), hence they are not always the ideal option.

Moreover, Flowback can be generated in the ADR Shares (operation that convert the ADR securities into shares to be quoted in the market of origin). Also, Inflow process may take place.

From the company’s perspective:

  •    The market where the company is listed is expanding hencet the price may become more stable.
  •    Find new investors — more financing.
  •    Improves the brand image of the company in the United States.

From the investor’s perspective:

  •    It oftens means a saving of commissions.
  •    For the American investors, there is no need to examine the language of the market of origin or even its taxation.
  •    Investor can take advantage of the trading volume of a US stock exchange.

Disadvantages of the ADR Shares

  •  The exchange rate (currency) risk may arise.
  •    For the investor, the commissions can be higher in the United States since, among others; also, depository banks imposes an additional commission.
  •    Based on the company, liquidity problems may also arise.

References for American Depositary Receipt

Academic Research for American Depository Receipt

The market reaction to SEC IFRS-related announcements: The case of American Depository Receipt (ADR) firms in the US, Prather-Kinsey, J. J., & Tanyi, P. N. (2014). Accounting Horizons, 28(3), 579-603. The purpose of this study is to determine whether the International Financial Reporting Standards (IFRS) in the United States (U.S.) is taken as positively by the American Depository Receipt (ADR) firms’ equity market firms. Our tests are based on analyzing market behavior towards the Securities and Exchange Commission’s (SEC) IFRS-related press releases, in between 2007 and 2011, for the potential application of IFRS in the U.S. We used a sample consisting of ADR firms and multivariate regression analyses, then tested 3-day cumulative abnormal returns (CAR) of investors in response to announcements made by SEC on future IFRS adoption. A positive reaction has been observed. However, a negative response has been observed from the ADR firms reporting their financial statements at present, using U.S. generally accepted accounting principles (GAAP).

The American Depository Receipt (ADR): A creative financial tool for multinational companies, Haar, J., Dandapani, K., & Haar, S. P. (1990). Global Finance Journal, 1(2), 163-171.

Short-term and long-term performance of IPOs and SEOs traded as American depository receipts: Does timing matter?, Schaub, M., & Highfield, M. J. (2004). Journal of Asset Management, 5(4), 263-271. This paper evaluates the short-term and long-term returns of the foreign equities (our sample) that traded on the New York Stock Exchange as the American Depository Receipts (ADRs) in between 1st January, 1987, and 30th September, 2000. Differentiation has been observed in between those ADRs that were released as initial public offerings (IPOs) and as seasoned equity offerings (SEOs), as well as those before and after 1st June, 1998. The findings revealed that on average, ADR IPOs and SEOs released before 1st June, 1998, did not perform as expected on S&P500 in both short-term and long-term periods. On the contrary, the ADR IPOs and SEOs released after 1st June, 1998, either perform as expected or beyond S&P500 in both short-term and long-term periods. Overall, we conclude that non-negative and often positive cumulative wealth effects related to stock market timing might exist for ADR IPOs and SEOs trading.

The impact of listing Latin American ADRs on the risks and returns of the underlying shares, Martell, T. F., Rodriguez Jr, L., & Webb, G. P. (1999). Global Finance Journal, 10(2), 147-160. This paper evaluates the returns and risks of Latin American stocks after the American depository receipt (ADR) listings in the U.S. equity markets and didn’t observe any systematic volatility change. Notably, it backs the predictions made by Domowitz, Glen, and Madhavan’s 1998 in their model of international cross-listings. As per model’s predictions, the effects of these listings will vary across stocks as the net effect is indicates an exclusive trade-off for every individual stock between advantages of enhanced intermarket competition and costs arising from the diversion of information-linked orders out of the domestic market.

Investment performance of American depository receipts listed on the New York stock exchange: long and short, Schaub, M. (2003). The Journal of Business and Economic Studies, 9(2), 1.

A Report on the Attitudes of Foreign Companies Regardng a US Listing, Fanto, J. A., & Karmel, R. S. (1997). Stan. JL Bus. & Fin., 3, 51.

International cross‐listing and order flow migration: Evidence from an emerging market, Domowitz, I., Glen, J., & Madhavan, A. (1998). The Journal of Finance, 53(6), 2001-2027. Policymakers in rising markets are getting more worried for the impacts for the domestic equity market when firms list stock  overseas. It shows that the impacts of cross‐listing is based on the quality of intermarket information linkages. We studied these impacts through unique data from the Mexican equity market. The effect of cross‐listing is complicated—balancing the costs of order flow migration with the advantages of more intermarket competition. These impacts are enhanced by equity investment barriers inducing the segmentation of the domestic equity market.

Investor protection and the liquidity of cross-listed securities: Evidence from the ADR market, Chung, H. (2006). Journal of Banking & Finance, 30(5), 1485-1505. Using ‘American depository receipt’ (ADR) data on different countries, this paper investigates the association between firm liquidity and investor protection. Since poor investor protection results in expropriation by managers, and therefore more asymmetric information costs, liquidity providers will face comparatively higher costs and hence, will eventually offer higher bid–ask spreads. The empirical outcomes show that the liquidity costs of such investor protection were more visible during the time of the Asian financial crisis as that time the expected agency costs were quite severe. This is further examined by determining whether there is any proof of increase in the vulnerability of ADRs of businesses running in countries with comparatively poor investor protection systems during financial crisis.

Stock return autocorrelation and institutional investors: the case of American depository receipt, Diane Li, D., & Yung, K. (2006). Stock return autocorrelation and institutional investors: the case of American depository receipt. Review of Accounting and Finance, 5(1), 45-58. – The results show that the ADR individual stock and portfolio daily return are closely and positively linked to the institutional ownership. It also reveals that non‐synchronous trading, bid‐ask spread and volatility of ADR, are unable to describe the positive relation between daily return autocorrelations and institutional ownership of ADR.

How American are America Depository Receipts-ADRs, Rule 10b-5 Suits, and Morrison v. National Australia Bank, Chiappini, V. M. (2011). BCL Rev., 52, 1795.

American depository receipts, listing, and market efficiency: Three Case Studies, Webster, T. J. (1998). The Mid-Atlantic Journal of Business, 34(3), 273.

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