What is American Depositary Receipt?

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The term American depositary receipt (ADR) refers to a negotiable certificate issued by a U.S. depositary bank representing a specified number of shares—usually one share—of a foreign company's stock. The ADR trades on U.S. stock markets as any domestic shares would.ADRs offer U.S. investors a way to purchase stock in overseas companies that would not otherwise be available. Foreign firms also benefit, as ADRs enable them to attract American investors and capital without the hassle and expense of listing on U.S. stock exchanges.

Definition

An American Depositary Receipt (ADR) is a negotiable certificate issued by a U.S. depositary bank representing a specific number of shares, usually one, of a foreign company's stock. ADRs can be traded on U.S. stock markets just like any domestic stock. They provide U.S. investors with a way to purchase shares in foreign companies that would otherwise be inaccessible. Foreign companies benefit as well, as ADRs allow them to attract U.S. investors and capital without having to list on U.S. stock exchanges, thus avoiding the associated hassle and expense.

Origin

The concept of ADRs originated in 1927 when J.P. Morgan issued the first ADR for the British department store Selfridges. This innovation made it easier for U.S. investors to invest in foreign companies and provided a pathway for foreign companies to access U.S. capital markets.

Categories and Features

ADRs are primarily categorized into three levels: Level I, Level II, and Level III. Level I ADRs are traded over-the-counter and have the least stringent disclosure requirements. Level II ADRs are listed on major U.S. stock exchanges and must comply with more rigorous SEC reporting requirements. Level III ADRs allow foreign companies to raise capital in the U.S. market by issuing new shares and must meet the strictest listing and reporting standards. Key features of ADRs include simplified trading processes, pricing in U.S. dollars, and liquidity in the U.S. market.

Case Studies

A typical case is Alibaba Group's 2014 ADR listing on the New York Stock Exchange, raising $25 billion, which was one of the largest IPOs globally at the time. Another example is the Swiss pharmaceutical company Novartis, whose ADRs trade on the New York Stock Exchange, enabling it to attract a significant number of U.S. investors.

Common Issues

Investors using ADRs may encounter issues such as currency exchange risk, foreign taxes, and differing accounting standards. Additionally, investors might misunderstand the difference between ADRs and directly holding foreign stocks, which can involve more complexity and costs.

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