What Is an ADR? American Depositary Receipts Explained

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An American depositary receipt (ADR) is a U.S. dollar-denominated security, issued by a U.S. depositary bank, that represents a specific number of shares (or a fraction of one share) of a foreign company held in custody abroad. ADR stock trades in the United States on an exchange such as the NYSE or Nasdaq, or over the counter (OTC). This lets an American investor buy exposure to a company listed in London, Tokyo or Frankfurt through an ordinary U.S. brokerage account, in dollars, during U.S. market hours.

The receipt is not the foreign share itself. It is a claim on shares held by the depositary bank, and the holder’s rights, costs and currency exposure come from that structure.

How an ADR Works

Creating an ADR starts with real shares in the company’s home market. A U.S. depositary bank, or a broker acting through it, buys ordinary shares of the foreign company on its local exchange. Those shares are held by a custodian bank in the home country, often a branch or partner of the depositary. The depositary then issues ADRs in the United States against the deposited shares, at a fixed ratio.

From there, the ADR trades like any U.S.-listed stock. It has a ticker, a dollar price, a bid and ask, and it settles through the U.S. clearing system. A buyer does not need a foreign brokerage account, a foreign currency balance or access to an overseas exchange.

The bank handles the plumbing that a direct foreign purchase would otherwise require:

• Dividends: the foreign company pays dividends in its own currency to the custodian. The depositary converts them to dollars and passes them to ADR holders, after deducting any foreign tax withheld and its own fees.
• Corporate actions: stock splits, rights offerings and other events at the foreign company are reflected in the ADR, sometimes through a change in the ratio.
• Shareholder communications: for sponsored programs, the depositary distributes company reports and, where the deposit agreement allows it, voting materials.

Creation, Cancellation and Price Alignment

ADRs are not a fixed pool. When demand rises, brokers can buy ordinary shares abroad, deliver them to the custodian and have new ADRs issued. When demand falls, they can surrender ADRs to the depositary, cancel them and take back the underlying shares to sell in the home market.

This two-way conversion keeps an ADR’s price close to the value of the shares it represents. If an ADR trades at a premium to the underlying shares (after adjusting for the ratio and the exchange rate), an arbitrageur can buy the cheaper ordinary shares, convert them into ADRs and sell the ADRs. At a discount, the trade runs the other way. Conversion costs and time, and gaps when one market is closed and the other open, keep prices from matching perfectly, but arbitrage limits how far they drift.

The ADR Ratio

The depositary sets how many foreign shares each ADR represents. A ratio of 1:1 means one ADR equals one ordinary share. A ratio such as 1:5 means one ADR equals five shares, and a ratio such as 4:1 means four ADRs equal one share.

Banks choose the ratio to put the ADR price in a range that suits U.S. trading. A share worth a few cents abroad would be bundled so the ADR does not look like a penny stock, while a share worth thousands of dollars might be split into fractions. The ratio matters whenever you compare the ADR price to the home-market price, or per-share figures such as earnings per share reported in the company’s own currency.

Worked Example: What an ADR Price Means

The ADR price is the dollar value of the underlying shares, multiplied by the ratio. The relationship can be written as:

Implied ADR price = home-market share price × shares per ADR × exchange rate (USD per unit of local currency)

Hypothetical example. A German company’s shares trade at €40 in Frankfurt. Each ADR represents 3 shares, and the exchange rate is $1.10 per euro.

• Implied ADR price = €40 × 3 × 1.10 = $132

Now suppose the Frankfurt price stays at €40, but the euro weakens to $1.00.

• New implied ADR price = €40 × 3 × 1.00 = $120

The ADR has fallen about 9.1% even though the Frankfurt price did not move, and a stronger euro would lift it with no change in Frankfurt. Because the ratio is fixed, every move in the exchange rate shows up in the dollar price.

The same mechanics apply to dividends. Hypothetical example, continued: the company pays €1 per share, so each ADR is entitled to €3. Assume, for illustration only, a 15% foreign withholding rate and a depositary fee of $0.02 per ADR.

1. Gross dividend per ADR: €3
2. Less 15% withholding: €3 × 0.85 = €2.55
3. Converted at $1.10: $2.805
4. Less depositary fee: $2.805 − $0.02 = about $2.79 received per ADR

The investor’s U.S. tax reporting starts from the gross dividend in dollars ($3.30 in this example), with the €0.45 withheld (about $0.50) as foreign tax that may qualify for a credit. Actual withholding rates depend on the home country’s law and any tax treaty, and actual fees are set by each program.

Types of ADRs

Sponsored ADRs

In a sponsored program, the foreign company enters into a deposit agreement with one depositary bank. The company usually bears the cost of setting up the program, and the agreement defines the holders’ rights, the fees and how dividends and votes are handled. Only one sponsored ADR exists for a given class of shares, and the company keeps control over how its shares are represented in the U.S.

Sponsored ADRs are divided into levels according to how much U.S. market access the company wants and how much SEC reporting it accepts.

Unsponsored ADRs

An unsponsored ADR is set up by a depositary bank without the foreign company’s involvement, participation or even consent. It typically arises because U.S. investors want access to the stock and the bank sees demand. Since no company is party to the agreement, more than one bank can create an unsponsored ADR on the same company, and the different programs can carry different fee schedules and pass through dividends differently.

Unsponsored ADRs trade over the counter, not on a national exchange. They do not carry voting rights, and the investor receives no company-level commitment about information delivered to U.S. holders.

Level I

Level I is the entry tier for sponsored programs. The ADRs trade OTC, the company need not file full SEC reports or reconcile its accounts to U.S. accounting standards, and the program cannot raise new capital in the U.S. It is a low-cost way to establish a U.S. trading presence and gauge investor interest. For investors, lighter disclosure and thinner OTC trading make Level I ADRs harder to analyze and potentially more expensive to trade.

Level II

Level II ADRs list on a U.S. exchange. The company must register with the SEC, file an annual report (Form 20-F for foreign private issuers) and meet the exchange’s listing standards. A Level II program still does not raise capital, but exchange listing usually brings more visibility and trading volume than OTC trading.

Level III

Level III is the highest tier. The company lists on a U.S. exchange and sells new ADRs to the public in a registered offering, which is how a foreign company runs an ADR IPO or a follow-on offering in the United States. It takes on full SEC registration and reporting obligations and gains the largest U.S. presence and direct access to U.S. capital.

Restricted ADRs

Outside the three levels, companies can also raise money privately through restricted depositary receipts, such as those sold to qualified institutional buyers under SEC Rule 144A. These are not available to ordinary retail investors and do not trade on public U.S. exchanges.

Why Companies Issue ADRs and Why Investors Use Them

For the foreign company, an ADR program widens the pool of potential shareholders. A U.S. listing can bring more analyst coverage, more trading in the stock and a recognized name among American investors. A Level III program goes further and lets the company raise equity directly from U.S. investors.

For the investor, the appeal is access with familiar mechanics:

• Same brokerage account: no foreign account or local currency is needed.
• Dollar quotes and dollar dividends: prices, trades and income are in dollars, with conversion handled by the depositary.
• U.S. trading hours and settlement: orders go through the same systems as domestic stocks.
• Diversification: exposure to companies, industries and economies that U.S. listings alone may not cover.
• Comparable research: exchange-listed ADRs file annual reports with the SEC, so measures such as the P/E ratio can be calculated from public filings (after adjusting for the ADR ratio and currency).

Costs and Taxes

Depositary Fees

ADRs can carry charges that domestic shares do not. The depositary may charge a periodic custody or service fee, commonly cited at about one to three cents per ADR share and set out in the deposit agreement or program documents. The bank deducts it from dividends or, when no dividend is due, collects it through the investor’s broker, often as a small debit on a brokerage statement. Issuance and cancellation fees apply when ADRs are created or converted back into ordinary shares, and currency conversion on dividends has its own cost.

Taxes on Dividends and Gains

Dividends from ADRs are taxable in the United States like other dividends, and they may also be taxed by the company’s home country. The foreign tax is usually withheld at source before the dividend reaches the depositary, so investors receive a net amount.

To avoid paying tax twice on the same income, U.S. taxpayers can generally claim a foreign tax credit for the foreign tax withheld (subject to IRS limits), or deduct it instead. In some cases the home country allows investors to reclaim part of the withholding if it exceeded the treaty rate. Whether ADR dividends count as qualified dividends for the lower U.S. tax rate depends on the company and how long the investor held the shares.

Selling an ADR is treated like selling any other security for U.S. tax purposes: the gain or loss is the difference between the dollar sale proceeds and the dollar cost basis. In tax-advantaged accounts such as IRAs, the foreign withholding generally cannot be recovered through a credit, which reduces the net yield of a dividend-paying ADR held there.

Limitations and Risks

Currency risk remains. As the worked example shows, a dollar quote does not remove exposure to the home currency. Exchange-rate moves (including broad dollar trends tracked by the U.S. Dollar Index) pass straight into the ADR price and its dividends.

Rights are defined by the deposit agreement. An ADR holder has an interest in shares held by the depositary, not a direct entry on the company’s share register. In sponsored programs, holders can often instruct the depositary how to vote, but the process runs through the bank and its deadlines. Unsponsored ADR holders have no voting rights.

Uneven disclosure. Level I and unsponsored ADRs do not require full SEC reporting, so information may be limited to what the company publishes at home, possibly in another language and under different accounting standards.

Limited selection. Only foreign companies with an ADR program can be bought this way. More than 2,000 ADRs from more than 70 countries have been cited, but that is still a fraction of all listed companies worldwide.

Program changes. A company can terminate its program or move between levels. Holders then have to choose between selling, converting into ordinary shares or switching to another ADR, as the Volkswagen case below shows.

Home-market risks. The ADR inherits the political, legal and economic risks of the company’s country, along with any differences in shareholder protections.

History and a Case Study

Guaranty Trust Company of New York, a predecessor of J.P. Morgan, created the first ADR in 1927, giving U.S. investors access to the British department store Selfridges, whose shares would otherwise have had to be bought on a foreign exchange. In 1931 the bank created the first sponsored ADR, for the British music and electronics company Electrical & Musical Industries (EMI). J.P. Morgan and BNY Mellon remain active depositary banks.

Volkswagen shows how a program change affects holders. The German automaker traded OTC in the U.S. as a sponsored ADR under the ticker VLKAY from 1988 until August 2018, when Volkswagen terminated the program. One day later, J.P. Morgan set up an unsponsored ADR under the ticker VWAGY. VLKAY holders could sell for cash, exchange their receipts for ordinary Volkswagen shares traded on German exchanges, or switch into VWAGY. The stock stayed available to U.S. investors, but with no company sponsorship behind it.

ADRs vs. Related Terms

ADR vs. ADS

The terms are often used interchangeably, but strictly, the American depositary share (ADS) is the unit that trades, while the ADR is the receipt or certificate that evidences ownership of one or more ADSs. In practice, a quote for “the ADR” is a quote for one ADS.

ADR vs. GDR

A global depositary receipt (GDR) follows the same structure but is designed for more than one market, most often the U.S. and European markets, with a single fungible security. Companies tend to use GDRs when raising capital in their home market and internationally at the same time, through public offerings or private placements. An ADR is aimed at the U.S. market alone.

ADR vs. Ordinary Shares Held Directly

An investor can sometimes buy a foreign company’s ordinary shares directly, either on the home exchange through an international broker or OTC in the U.S. as a “foreign ordinary.” Direct ownership puts the investor on the company’s share register and avoids depositary fees, but often involves foreign currency trading, foreign settlement and less convenient dividend handling. The ADR trades convenience for an extra layer of intermediation.

ADR vs. a U.S.-Listed Foreign Company

Some foreign companies list their ordinary shares directly on a U.S. exchange without an ADR, and some U.S.-registered companies have most of their operations abroad. A depositary bank and a deposit agreement are what define an ADR. Owning one is still ownership of an interest in company equity, but it is held through the bank’s structure.

The Bottom Line

ADRs suit U.S. investors who want foreign stocks in an ordinary brokerage account, with dollar prices and dollar dividends. That convenience comes with currency exposure, depositary fees, foreign tax withholding and rights set by the deposit agreement. Exchange-listed sponsored programs offer the fullest disclosure, while unsponsored and Level I ADRs give thinner information and no company commitment to U.S. holders.