CluenexWhat is an ADR?
An American Depositary Receipt (ADR) is a negotiable certificate issued by a US depositary bank. It represents a specified number of shares in a foreign company, and the bank or its local custodian holds those shares in the company's home market. The receipt trades in US dollars during US hours.
The reason this exists is practical. A share listed in Seoul, Taipei or Frankfurt settles in a foreign currency, through a foreign clearing system, on foreign hours. A US brokerage account usually cannot hold it directly.
The ADR bridges that gap without moving the share. The shares stay abroad, and the certificate that points to them trades at home in the US.
How is an ADR created?
A depositary bank creates ADRs by holding foreign shares in custody and issuing receipts against them. The process has four steps:
- Shares are acquired. In a capital-raising listing, the company issues new shares to the depositary. In other programs, a broker buys existing shares on the home exchange.
- A local custodian holds them. A bank in the home market keeps the shares and confirms the position to the depositary.
- Receipts are issued. Each receipt represents a number of shares fixed in the deposit agreement.
- Receipts trade in the US. Exchange-listed ADRs trade on the NYSE or Nasdaq. Others trade over the counter, meaning through dealers rather than on an exchange.
The process also runs in reverse. ADRs can be cancelled and the shares released, which is one reason ADR prices stay close to home-market prices.
What is an ADR ratio, and why does it matter?
The ADR ratio is how many underlying shares one ADR represents. It is chosen when the program is set up, often to place the ADR price in a range US investors are used to. It can be more than one share per ADR, one-to-one, or a fraction of a share.
Taiwan Semiconductor's ADR is a well-known example: it has represented five ordinary shares. Always confirm the current ratio on the depositary's program page, because it can change.
Here is a hypothetical worked example of what the ratio does:
- Home share price: 1,000 units of local currency
- Ratio: 1 ADR = 5 shares, so one ADR is backed by 5,000 local units
- Exchange rate: 32 local units per dollar
- Expected ADR price: 5,000 / 32 = $156.25
If someone compared $156.25 with the home price of 1,000 and called the ADR expensive, the comparison would be meaningless. Per-share figures such as earnings per share, dividends and book value must all be adjusted by the same ratio.
What are the types of ADR programs?
Programs differ in where they trade and how much the company must disclose.
| Program | Where it trades | Company involvement | Disclosure |
|---|---|---|---|
| Level I | Over the counter | Sponsored or unsponsored | Minimal; home-market reporting |
| Level II | NYSE or Nasdaq | Sponsored | SEC registration, annual report on Form 20-F |
| Level III | NYSE or Nasdaq | Sponsored, raises new capital | Same as Level II plus an offering prospectus |
| Rule 144A | Private placement | Sponsored | Qualified institutional buyers only |
A sponsored ADR is set up by the company under an agreement with one depositary. An unsponsored ADR is created by a bank without the company's participation, and several unsponsored programs can exist for one company with different ratios.
Sponsored programs generally give clearer disclosure and voting arrangements. Form 20-F is the annual report that foreign private issuers file with the SEC, a rough equivalent of the 10-K.
What do you actually own with an ADR?
You own the economic interest in the underlying shares. Price changes in the home market pass through, adjusted for the ratio and the exchange rate. Dividends are declared in the home currency, converted to dollars by the depositary and paid to you.
Voting rights depend on the deposit agreement. In many sponsored programs, the depositary collects voting instructions from holders. In others, voting is limited.
Two things attach to an ADR that a US domestic share does not have.
Currency translation. The company earns and reports in its home currency, while the ADR is priced in dollars. Continuing the example above, suppose the local currency weakens 10% against the dollar, from 32 to 35.2 units per dollar, and the home share price stays at 1,000.
- New ADR value: 5,000 / 35.2 = $142.05
- Change: ($142.05 - $156.25) / $156.25 = about -9.1%
The business did nothing wrong, yet the dollar value fell. The reverse also holds when the foreign currency strengthens. Standard ADRs are not hedged against this. See US Dollar Strength and Its Effect on Multinational Stock Earnings for the corporate side of the same effect.
Fees and taxes. Depositaries charge service fees, which the SEC's investor bulletin describes as commonly $0.01 to $0.05 per ADR per year. They are usually taken from dividends or billed through the broker. On 200 ADRs at $0.02, that is $4 a year.
The home country may also withhold tax on dividends before they reach you. The rate depends on the tax treaty with the US. A US investor can often claim a credit for foreign tax paid, so check your tax form or ask a tax professional.
Why do foreign companies issue ADRs?
There are three main reasons:
- Access to capital. US markets hold large pools of pension, retirement and fund money. A Level III offering lets a company raise new money from it.
- Eligibility. Some US funds can only hold securities that trade on a US exchange or settle in dollars. A listed ADR can make a company eligible.
- Visibility. A US listing can bring analyst coverage and trading during US hours.
The cost is disclosure. Exchange-listed programs must register with the SEC and file reports such as Form 20-F, so the company takes on more regulatory work.
Where does the ADR idea fail, and what are the common mistakes?
The ADR wrapper changes where and how you trade, not the risks of the business.
"One ADR equals one share." Ratios vary. Check the deposit agreement before comparing prices or per-share numbers.
"The ADR price always equals the converted home price." The two stay close because ADRs can be created and cancelled. Gaps still appear when the home market is closed, and they can widen if creating or cancelling ADRs is restricted.
"Dollars mean no foreign risk." Dollar pricing changes the currency you trade in, not the exposure. Foreign regulation, politics and economic conditions reach the business and therefore the ADR. For an extreme case, see Investing in Chinese Stocks: VIEs, Delisting Risk, and What You Own.
"An unsponsored ADR is the same as a sponsored one." Unsponsored programs may have weaker disclosure and unclear voting rights.
"A huge listing means a good price." The size of an offering tells you how much money the company raised, not whether the price is fair. Compare the price with the company's earnings and cash flow, not with the headline amount. Forward P/E vs Trailing P/E covers a standard way to do that.
Also note that US-style investing tools may not fully apply. For instance, insider and congressional trade data come from US filings, while insiders at a foreign company follow home-country disclosure rules, often on a different schedule.
What this means for you
If you own or are considering an ADR in a regular brokerage account, a short checklist covers most of the traps:
- Find the ratio. Look it up on the depositary's program page or in the deposit agreement before comparing any per-share number.
- Check the program level. An exchange-listed Level II or III ADR files with the SEC. A Level I over-the-counter ADR gives you far less information.
- Name the currency. Know which currency the company earns in, and accept that your dollar result will include that currency's moves.
- Read the fee and tax lines. On your dividend statement, look for depositary fees and foreign withholding, and keep the records for tax time.
- Watch concentration. Several ADRs from one country add up to a single currency and political bet. Single-Country ETFs explains how that exposure builds.
Cluenex covers about 1,000 large US-listed stocks and explains how it values them at https://cluenex.com/guides/how-we-value/. Whatever tool you use, keep currency risk in mind, because no company-level valuation forecasts an exchange rate.