"An American Depositary Receipt (ADR nedir) is a share of stock of an investment in shares of a non-US corporation. The shares of the non-US corporation trade on a non-US exchange, while the ADRs, perhaps somewhat obviously, trade on a US exchange. This mechanism makes it straightforward for a US investor to invest in a foreign issue. ADRs were first introduced in 1927.
Two banks are generally involved in maintaining an ADR on a US exchange: an investment bank and a depositary bank. The investment bank purchases the foreign shares and offers them for sale in the US. The depositary bank handles the issuance and cancellation of ADRs certificates backed by ordinary shares based on investor orders, as well as other services provided to an issuer of ADRS, but is not involved in selling the ADRs.
To establish an ADR, an investment bank arranges to buy the shares ona foreign market and issue the ADRs on the US markets.
For example, BigCitibank might purchase 25 million shares of a non-US stock. Call it EuroGlom Corporation (EGC). Perhaps EGC trades on the Paris exchange, where BigCitibank bought them. BigCitibank would then register with the SEC and offer for sale shares of EGC ADRs.
EGC ADRs are valued in dollars, and BigCitibank could apply to the NYSE to list them. In effect, they are repackaged EGC shares, backed by EGC shares owned by BigCitibank, and they would then trade like any other stock on the NYSE.
BigCitibank would take a management fee for their efforts, and the number of EGC shares represented by EGC ADRs would effectively decrease, so the price would go down a slight amount; or EGC itself might pay BigCitibank their fee in return for helping to establish a US market for EGC. Naturally, currency fluctuations will affect the US Dollar price of the ADR.
BigCitibank would set up an arrangement with another large financial institution for that institution to act as the depositary bank for the ADRs. The depositary would handle the day-to-day interaction with holders of the ADRs.
Dividends paid by EGC are received by BigCitibank and distributed proportionally to EGC ADR holders. If EGC withholds (foreign) tax on the dividends before this distribution, then BigCitibank will withhold a proportional amount before distributing the dividend to ADR holders, and will report on a Form 1099-Div both the gross dividend and the amount of foreign tax withheld.
Most of the time the foreign nation permits US holders (BigCitibank in this case) to vote their shares on all or most issues, and ADR holders will receive ballots which will be received by BigCitibank and voted in proportion to ADR Shareholder's vote. I don't know if BigCitibank has the option of voting shares which ADR holders failed to vote.
The depositary bank sets the ratio of US ADRs per home country share. This ratio can be anywhere, and can be less than or greater than 1. Basically, it is an attempt to get the ADR within a price that Americans are comfortable with, so upon issue, I would assume that most ADRs range between $15 and $75 per share. If, in the home country, the shares are worth considerably less, than each ADR would represent several real shares. If, in the home country, shares were trading for the equivalent of several hundred dollars, each ADR would be only a fraction of a normal share.
Now, concerning who sets the price: yes, it floats on supply and demand. However, if the US price gets too far off from the price in the home country (Accounting for the currency exchange rate and the ratio of ADRs to home country shares), then an arbitrage opportunity will exist. So, yes, it does track the home country shares, but probably not exactly (for there are transaction costs in this type of arbitrage). However, if the spread gets too big, arbitragers will step in and then of course, the arbitrage opportunities will soon cease to exist."
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