What Is an American Depository Receipt? Meaning & Benefits for Investors

An American Depository Receipt (ADR) is a certificate that a United States bank issues to represent shares of a foreign company. Investors can trade these receipts on the United States stock markets, just like they trade local American shares.

ADRs allow United States investors to easily buy shares in foreign firms without using overseas exchanges. For example, suppose Reliance Industries wants to attract U.S. investors but doesn’t want to list directly in America. It can issue ADRs through a U.S. bank.

Example:

Assumed Exchange Rate: 1 USD = ₹82

So, a U.S. investor buys one ADR of Infosys at $20, and it equals one Infosys share worth ₹1,650 in India. This system makes global investing simple and accessible.

In this blog, we will explore how American Depository Receipts (ADRs) work, their benefits for international investors, and how they simplify investing in foreign companies from the United States.

How ADRs Work: A Simple Guide for Everyone

Imagine you love a special chocolate made only in Switzerland. You cannot travel there, but you still want to enjoy it. So, your local shopkeeper imports those Swiss chocolates, puts them in familiar wrappers, and sells them in rupees right in your city.

That’s exactly how American Depositary Receipts (ADRs) work in the stock market.

Step 1: A U.S. bank buys shares of a foreign company, such as Infosys in India.

Step 2: The bank keeps those shares in its overseas branch.

Step 3: The bank creates ADRs, each representing a specific number of foreign shares (e.g., 1 ADR = 2 Infosys shares).

Step 4: These ADRs are sold in U.S. dollars on American stock exchanges, just like normal U.S. shares.

Step 5: Investors in the U.S. can buy these ADRs easily, without dealing with different currencies or foreign regulations.

This way, American investors can own global shares as easily as buying imported chocolates from their local shop.

Purpose of American Depositary Receipts (ADRs)

ADRs were created to make investing in foreign companies easier and more accessible for U.S. investors. Instead of dealing with foreign stock exchanges, multiple currencies, and differing regulations, investors can buy ADRs in U.S. dollars on American stock markets just like regular domestic shares.

Key Objectives:
 

1. Simplify Global Investing: ADRs eliminate the need for investors to open overseas accounts or understand foreign trading rules.
    
2. Enhance Liquidity for Foreign Companies: By listing ADRs in the U.S., companies can attract a wider base of investors and increase trading volumes.
    
3. Offer Diversification: ADRs allow U.S. investors to diversify their portfolios internationally, spreading risk across different countries and industries.
    
4. Provide Transparency and Regulation: Sponsored ADRs follow U.S. financial reporting rules, giving investors confidence and reducing risks associated with foreign investments.

Overall, ADRs bridge the gap between domestic investors and foreign companies, offering convenience, regulatory oversight, and the ability to participate in international growth opportunities.

Understanding the Two Main Types of ADRs

American Depositary Receipts (ADRs) come in two main types. Think of it like selling a product from another country in your local market. Sometimes the company agrees to sell it officially, and sometimes the shop does it on its own. Let’s break it down.

1. Sponsored ADRs Official and Approved

ADRs can be categorised based on how they are issued and managed, with each type offering different levels of control, transparency, and trading privileges.
 

• A US bank works with a foreign company.
   
• The company signs an agreement and shares full financial details.
   
• These ADRs follow US rules and trade on big exchanges like the NYSE or Nasdaq.
   
• The company pays the cost and keeps some control.
   
• Only one ADR exists per company in this case.

Sponsored ADRs provide investors with official, regulated access to a foreign company’s shares while ensuring compliance with U.S. market standards and greater transparency

Example: Tata Motors works with a US bank to offer one official ADR on the NYSE.

2. Unsponsored ADRs Unofficial and Independent

Unsponsored ADRs are issued independently by U.S. banks without direct involvement or approval from the foreign company, offering an alternative way for investors to access international shares.
 

• A US bank issues ADRs without asking the foreign company.
   
• The company is not involved and may not even know.
   
• These ADRs trade over-the-counter, not on major exchanges.
   
• Different banks can create multiple ADRs for the same company.
   
• These ADRs do not offer voting rights to investors.

While unsponsored ADRs provide easier access to foreign stocks, they come with less transparency, no voting rights, and may trade on less regulated platforms compared to sponsored ADRs.

Example: A US bank lists an ADR for Infosys without Infosys directly joining in.

Unlocking the Three Levels of ADRs

American Depositary Receipts come in three levels. Each level shows how much a foreign company wants to take part in the United States market. As the level goes up, the company follows more rules and gets more benefits.

Let’s understand how each level works with a quick example and a helpful table.

Level I: Just Getting Started

A company uses Level I ADRs when it only wants to check investor interest in the US. It does not list its ADRs on big stock exchanges. The company does not raise any money and follows very few reporting rules.

Example: A small Korean electronics company wants to see if US investors like its shares. It uses Level I ADRs and sells them over the counter.

Level II: Gaining Attention

With Level II ADRs, the company wants to appear on large exchanges like the NASDAQ or the New York Stock Exchange. It still does not raise capital but follows more reporting rules than Level I.

Example: A European airline lists Level II ADRs on the NYSE to become more visible to US investors.

Level III: Full Participation

Level III ADRs are used when the company wants to raise money directly from US investors. It is listed on top US exchanges and must follow all the rules set by the Securities and Exchange Commission.

Example: An Indian software company uses Level III ADRs to raise funds and expand its business in the United States.

Comparison Table of ADR Levels
 

This comparison highlights how different ADR levels offer varying degrees of access, transparency, and fundraising potential for foreign companies looking to engage U.S. investors.

Advantages and Disadvantages of American Depositary Receipts (ADRs)

American Depositary Receipts or ADRs let people in the United States invest in companies based outside the country. They make international investing easier and more familiar, but they also come with a few risks. Let us look at the benefits and drawbacks in a simple and clear way.

What Makes ADRs a Popular Choice?

Investing in American Depositary Receipts (ADRs) offers U.S. investors a simple and effective way to gain exposure to international companies without leaving the domestic market.

1. Simple to Buy and Sell

You can trade ADRs on regular stock markets in the United States. If you know how to buy shares of an American company, then you already know how to trade ADRs. It feels no different from buying any local stock.

2. Available Through Local Brokers

You do not need to go through foreign banks or brokers. Most American brokers let you buy ADRs directly. This saves time and effort and makes the whole process more convenient.

3. Prices in U.S. Dollars

Since ADRs are priced in dollars, you do not need to worry about converting foreign money. You can track the share price easily, without thinking about currency changes.

4. Diversifies Your Investment Portfolio

ADRs give you the chance to invest in businesses from other parts of the world. This helps you spread your risk. If one country’s market does badly, another country might still perform well.

Overall, ADRs combine convenience, transparency, and diversification, making them an attractive option for investors looking to participate in global markets from the U.S.

What Should You Be Careful About?

While ADRs offer convenient access to international stocks, investors should be aware of certain risks and limitations before investing.

1. Possible Double Taxation

You might need to pay tax both in the company’s home country and again in the United States. This can reduce the money you make from your investment.

2. Limited Company Options

Only a small number of international companies offer ADRs. So while you can invest globally, your choices will not be as wide as with American companies.

3. Not All ADRs Follow U.S. Rules

Some ADRs are called unsponsored. These are listed without the company’s direct involvement. They may not follow United States financial rules, which could make them less safe for investors.

4. Currency Conversion Fees May Apply

Even though ADRs are in dollars, behind the scenes there is still a link to the foreign company’s shares. This process can lead to conversion charges, which reduce your overall returns.

Being aware of these factors can help investors make informed decisions and manage risks effectively when adding ADRs to their portfolio.

Conclusion

American Depositary Receipts make it easy for U.S. investors to buy shares in foreign companies without using foreign exchanges. They offer a simple way to diversify and access global markets. However, like all investments, they come with risks. Understanding both sides helps you make smarter investment choices.

FAQ’s

Why do investors choose ADRs instead of buying foreign shares directly?
ADRs simplify global investing by letting U.S. investors trade foreign stocks like domestic ones, avoiding foreign exchange hassles.
 

Can ADRs fluctuate differently than the underlying foreign shares?
Yes, ADR prices may vary due to currency exchange rates, U.S. market demand, and local market conditions abroad.
 

Do ADR holders receive dividends?
Yes, dividends are paid in U.S. dollars after conversion from the foreign company’s currency, sometimes with withholding taxes applied.
 

What distinguishes sponsored from unsponsored ADRs?
Sponsored ADRs involve the foreign company directly and comply with full U.S. regulations, while unsponsored ADRs are issued independently by U.S. banks.
 

Can ADRs be delisted or suspended?
Yes, if the foreign company fails to meet U.S. reporting standards or chooses to stop the ADR program, trading can be halted or terminated.

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LoansJagat Team

We are a team of writers, editors, and proofreaders with 15+ years of experience in the finance field. We are your personal finance gurus! But, we will explain everything in simplified language. Our aim is to make personal and business finance easier for you. While we help you upgrade your financial knowledge, why don't you read some of our blogs?