American Depository Receipt (ADR)

American Depository Receipt (ADR)

Introduction

With the expansion of global trade and cross-border investments, companies often seek to raise funds outside their home country. One important instrument that allows foreign companies to raise capital from the United States is the American Depository Receipt (ADR).

Meaning of American Depository Receipt (ADR)

An American Depository Receipt (ADR) is a negotiable financial instrument issued by a US depository bank, representing a specified number of shares of a foreign company. These shares are held by a custodian bank in the home country of the foreign company.

In simple terms, ADRs allow US investors to invest in foreign companies without dealing with foreign stock exchanges, currencies or settlement systems. ADRs are traded in US dollars on US stock exchanges such as NYSE, NASDAQ or AMEX.

How ADRs Work

The process of issuing ADRs involves multiple steps.

A foreign company first deposits its shares with a custodian bank in its home country. A US depository bank then issues ADRs against these shares. These ADRs are listed and traded in US markets just like domestic shares.

Each ADR may represent:

  • One share of the foreign company
  • Multiple shares
  • Or a fraction of a share

The ratio is decided to make the ADR price attractive to US investors.

Objectives of Issuing ADRs

Companies issue ADRs for several reasons:

  • To raise capital from the US market
  • To increase global visibility and brand image
  • To diversify investor base
  • To obtain better valuation compared to domestic markets

For investors, ADRs provide access to international diversification without complexities of foreign markets.

Types of ADRs

Sponsored ADRs

Sponsored ADRs are issued with the active involvement of the foreign company. The company enters into an agreement with a US depository bank.

Sponsored ADRs can be:

  • Level I ADRs – Traded in OTC market, limited disclosure
  • Level II ADRs – Listed on US exchanges, higher disclosure
  • Level III ADRs – Used to raise capital through public offering in US

Level III ADRs involve strict compliance with SEC regulations.

Unsponsored ADRs

Unsponsored ADRs are issued without direct involvement of the foreign company. One or more depository banks can issue these ADRs based on market demand.

These ADRs:

  • Trade in OTC markets
  • Have limited disclosure
  • Do not raise fresh capital for the company

Pricing of ADRs

The price of an ADR depends on:

  • Price of underlying shares in home country
  • ADR ratio
  • Exchange rate between USD and home currency

Any major difference between ADR price and underlying share price is corrected through arbitrage, ensuring price parity.

Rights of ADR Holders

ADR holders generally enjoy rights similar to equity shareholders.

These include:

  • Right to receive dividends (in USD)
  • Right to vote (through depository bank)
  • Right to corporate benefits like bonus or rights issue

However, voting rights are exercised indirectly.

Advantages of ADRs

For Issuing Companies

ADRs help companies:

  • Access deep and liquid US capital markets
  • Improve international credibility
  • Broaden shareholder base
  • Reduce dependence on domestic markets

For Investors

US investors benefit because:

  • ADRs are traded in USD
  • Settlement follows US market norms
  • No need to deal with foreign regulations
  • Easy diversification into global equities

Risks Associated with ADRs

Despite advantages, ADRs carry certain risks.

  • Exchange rate risk, as underlying shares are in foreign currency
  • Political and economic risk of issuing country
  • Regulatory risk due to changes in foreign laws
  • Market risk like any equity investment

ADRs vs GDRs (Brief Comparison)

While ADRs are listed in US markets, Global Depository Receipts (GDRs) are usually listed in European markets like London or Luxembourg. ADRs are subject to stricter disclosure norms under US laws compared to GDRs.

Role of ADRs in Indian Context

Many Indian companies such as Infosys, ICICI Bank and Wipro have issued ADRs to access US investors. ADRs have helped Indian companies gain international recognition and raise foreign currency funds.

From a banking point of view, ADRs contribute to:

  • Inflow of foreign capital
  • Strengthening of balance of payments
  • Global integration of Indian capital markets

Conclusion

American Depository Receipts are an important instrument in international capital markets. They bridge the gap between foreign companies and US investors by simplifying cross-border equity investment. For bankers and finance professionals, understanding ADRs is essential for corporate finance, treasury operations and international banking.