American Depository Receipt (ADR) - Interdisciplinary Issues in Indian Commerce | Interdisciplinary Issues in Indian Commerce - B Com PDF Download

American Depository Receipt represents the shares of a foreign company issued by U.S bank which can be traded in U.S. equity markets.

Meaning Of American Depository Receipt

American Depository Receipt (ADR) is a certified negotiable instrument issued by an American bank suggesting the number of shares of a foreign company that can be traded in U.S. financial markets.

American Depository Receipts provide US investors with an opportunity to trade in shares of a foreign company. When the ADRs did not exist, it was very difficult for an American investor to trade in shares of foreign companies as they had to go through many rules and regulation. To ease such hardship faced by American investors, the regulatory body Securities Exchange Commission (SEC) introduced the concept of ADR which made it easier for an American investor to trade in shares of foreign companies. American depository receipt fee varies from one cent to three cents per share depending upon the ADR amount and its timing.

American Depository Receipt Example

Volkswagen, a German company trades on New York Stock Exchange. The investor in America can easily invest into the German company, through the stock exchange. Volkswagen is listed on the American stock exchange after complying the required laws. On other hand if the shares of Volkswagen are listed in stock markets of countries other than US then it is termed as GDR.

American Depository Receipt Process

• The domestic company, already listed in its local stock exchange, sells its shares in bulk to a U.S. bank to get itself listed on U.S. exchange.
• The U.S. bank accepts the shares of the issuing company. The bank keeps the shares in its security and issues certificates (ADRs) to the interested investors through the exchange.
• Investors set the price of the ADRs through bidding process in U.S. dollars. The buying and selling in ADR shares by the investors is possible only after the major U.S. stock exchange lists the bank certificates for trading.
• The U.S. stock exchange is regulated by Securities Exchange Commission, which keeps a check on necessary compliances that need to be complied by the foreign company.

Advantages Of American Depository Receipt

 Following are the advantages of ADRs:

• The American investor can invest in foreign companies which can fetch him higher returns.
• The companies located in foreign countries can get registered on American Stock Exchange and have its shares trades in two different countries.
• The benefit of currency fluctuation can be availed.
• It is an easier way to invest in foreign companies as there are no restrictions to invest in ADR.
• ADR simplifies tax calculations. Trading in shares of foreign company in ADR would lead to tax under US jurisdiction and not in the home country of company.
• The pricing of shares of foreign companies in ADR is generally cheaper. Hence it provides additional benefit to investors.

 Disadvantages Of American Depository Receipt

 The following are the disadvantages of American Depository Receipts:

• Even though the transactions in ADR take place in US dollars, still they are exposed to the risk associated with foreign exchangefluctuation.
• The number of options to invest in foreign companies is limited. Only few companies feel the necessity to register themselves through ADR. This limits the choice available to US investor to invest.
• The investment in companies opting for ADR often becomes illiquid as investor needs to hold the shares for long term to generate good returns.
• The charges for entire process of ADR are mostly transferred on investors by the foreign companies.
• Any violation of compliance can lead to strict action by Securities Exchange Commission.

Conclusion

ADRs provide the US investors with ability to trade in foreign companies shares. ADR makes it easier and convenient for the domestic investors in US to trade in foreign companies shares. ADR provides the investors an opportunity to diversify their portfolio by investing in companies which are not located in America. This eventually leads to investors investing in companies located in emerging markets, thereby leading to profit maximization for investors.

How It Works (Example): 

Investors can purchase ADRs from broker/dealers. These broker/dealers in turn can obtain ADRs for their clients in one of two ways: they can purchase already-issued ADRs on a U.S. exchange, or they can create new ADRs.

To create an ADR, a U.S.-based broker/dealer purchasesshares of the issuer  in question in the issuer's home market. The U.S. broker/dealer then deposits those shares in a bank in that market. The bank then issue ADRs representing those shares to the broker/dealer's custodin  or the broker-dealer itself, which can then apply them to the client's account.

A broker/dealer's decision to create new ADRs is largely based on its opinion of the availability of the shares, the pricing and market for the ADRs, and market conditions.

Broker/dealers don't always start the ADR creation process, but when they do, it is referred to as an unsponsored ADR program (meaning the foreign company itself has no active role in the creation of the ADRs). By contrast, foreign companies that wish to make their shares available to U.S. investors can initiate what are called sponsored ADR programs. Most ADR programs are sponsored, as foreign firms often choose to actively create ADRs in an effort to gain  access to American markets.

ADRs are issued and pay dividends in U.S. dollars, making them a good way for domestic investors to own shares of a foreign company without the complications of   currecy conversion. However, this does not mean ADRs are without currency risk  Rather, the company pays dividends in its native currency and the issuing bank distributes those dividends in dollars -- net of conversion costs and foreign taxes -- to ADR shareholders. When the exhange rate  changes, the value of the  dividendchanges.

For example, let's assume the ADRs of XYZ Company, a French company, pay an annual cash dividend  of 3 euros per share. Let's also assume that the exchange rate between the two currencies is even -- meaning one Euro has an equivalent value to one dollar. XYZ Company's dividend payment would therefore equal $3 from the perspective of a U.S. investor. However, if the euro were to suddenly decline in value to an exchange rate of one euro per $0.75, then the dividend payment for ADR investors would effectively fall to $2.25. The reverse is also true. If the euro were to strengthen to $1.50, then XYZ Company's annual dividend payment would be worth $4.50.

Why It Matters:

ADRs give U.S. investors the ability to easily purchase shares in foreign firms, and they are typically much more convenient and cost effective for domestic investors (versus purchasing stocks in overseas markets). And because many foreign firms are involved in industries and geographical markets where U.S. multinationals don't have a presence, investors can use ADRs to help diversify their portfolios on a much more global scale.