An American Depositary Receipt (ADR) is a certificate that lets investors invest in a foreign company on U.S. stock markets.
An American Depositary Receipt, ADR for short, is a certificate that represents a foreign stock that trades in the United States. Banks and brokerage firms in the U.S. issue or sponsor ADRs, and investors buy and sell them on U.S. stock markets, just like regular stocks. If you own an ADR, you have the right to obtain the foreign stock it represents. However, investors usually find it more convenient to continue holding ADRs.
One ADR may represent one or more shares of the foreign stock. But if the stock is expensive, the ADR may represent a fraction of a share. That way, the ADR will start trading at a moderate price, or be in range of similar stocks on the exchange where it trades. The price of an ADR usually stays close to the price of the foreign stock in its home market.
J.P. Morgan introduced ADRs in 1927 to make it easier for Americans to invest in Selfridge, the British retailer. ADRs have grown substantially since then. They make it practical for increasingly global-minded investors to invest in foreign companies, despite language barriers, shifting foreign exchange rates and the difficulty of trading on a foreign stock market.
Foreign firms benefit from ADRs in a number of ways: They let these companies offer dollar-denominated shares and raise capital in the U.S. Issuing ADRs also raises a non-U.S. firm’s liquidity and visibility, in the United States and around the world.
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How safe is it to invest in a American Depositary Receipt (ADR)?
ADRs make foreign investing much easier and safer for individual investors. The foreign company must provide detailed financial information to U.S. regulators, and to the sponsor, or “depositary,” bank or broker. Since ADRs trade on U.S. stock markets, you don’t have to worry about exchange rates, foreign stock-exchange rules, or the language barrier. Price information is readily available, and transaction costs are lower. Trades will clear and settle in U.S. dollars. As well, the depositary bank or broker will convert any dividends or other cash payments into U.S. dollars before it sends them on to you.
Depositary banks that issue ADRs sometimes charge fees for their services, and deduct these fees from the dividends and other distributions on the ADRs. The depositary bank also incurs expenses for services such as converting foreign currency into U.S. dollars, and passes these costs on to ADR holders. Sometimes, however, the foreign company pays the fees in return for the exposure to the U.S. market.
Although most foreign stocks that trade on U.S. markets do so through ADRs, other foreign stocks trade in the U.S. as stocks, just as they do on their local stock exchange. Canadian companies trade as stocks rather than ADRs in the U.S., for instance, just as they do on Canadian markets.
We believe most investors could benefit from holding some foreign investments in their portfolios for added diversification. Still, investing internationally remains riskier than investing in North America. With stocks markets around the globe, you may face, apart from language barriers, uncertain investor-protection laws, and in some cases a less pronounced commitment to openness, fairness and other qualities we tend to take for granted in established markets.
You’ll need to be highly selective with these investments. Yet they can help you cut risk, because American Depositary Receipts must follow some U.S. Securities and Exchange Commission and New York Stock Exchange rules. Note that at the same time, if you want to buy or sell stock in a company that only trades on a foreign stock market, and does not trade as an ADR, your broker may be able to process your order for you.
Have you had a positive or negative experience with foreign companies that use American Depositary Receipts? Post a comment and we will get back to you directly!
This article was originally published in 2010 and has been updated.
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