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 exchange fluctuation.
- 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.
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.