Definition: What you are actually buying when you invest in a foreign company that does not make its shares available for purchase in the U.S. It is such an effective substitute for the stock of the company that most investors who buy ADRs have no idea they’re actually doing so.
Example: Shikko Corporation is a Japanese company. It does not want to spend the time and money needed to meet the extensive requirements set by our Securities & Exchange Commission (SEC) to qualify to sell its shares in the U.S. However, Superior Bank, an international bank with offices in Japan and the U.S., wants to see these shares offered in the U.S. Therefore, Superior’s Japanese offices buy and hold large quantities of Shikko’s shares. They then create an ADR, a receipt that stands in the place of a share of Shikko. Superior registers the ADR with the SEC and ensures that it meets all of the requirements that Shikko didn’t want to. The receipt essentially states, ‘This receipt is proof that you have purchased and own a share of Shikko Corporation that we’re holding for you in our offices in Japan’.
Investeach explains: A bank is willing to invest the time and energy needed to meet the requirements of the SEC for offering shares in the U.S. because it is able to charge a fee to manage the ADR program. The fee is paid by the foreign company whose shares the bank created the ADRs for. It is worth paying because having ADRs available in the enormous U.S. market can dramatically increase the company’s world-wide base of owners.
It’s important to remember that ADRs, standing in the place of stock, are not shares of the stock itself. For example, holders of ADRs do not have voting rights. The bank holding the shares in the home of the foreign company has the right to vote them. However, dividends that are paid on the shares held by the bank in the foreign country are passed along by the bank to holders of the ADRs.
Finally, an ADR can stand in place of a single share, multiple shares, or a fraction of a share. Let’s say that in U.S. dollars, the value of a foreign company’s shares in its home country is $600. The bank arranging the ADR may think that this is too high a price for the average investor. To solve this problem, the ADR it creates is the equivalent of 1/10th of a share of the foreign company, making each ADR worth $60.
Riddle me this:
1. Why are some foreign companies not interested in listing their shares in the United States?
2. Who actually offers ADRs?
3. Which government agencies set the rules and requirements for making stock available in the United States?
4. Where are the shares the ADRs represent actually held?
5. In what way is holding an ADR different than holding a share of stock?
6. How do banks ensure that investors receive dividends that the foreign company pays out?
7. Why might a bank offer an ADR that is not equal to one share of the foreign company’s stock?