American Depositary Shares (ADSs): Ownership in Foreign Companies

August 31, 2024 4 min read Finance Investments Stock Markets Trading International Finance Foreign Investments Financial Instruments

American Depositary Shares (ADSs) are the actual shares issued under the ADR that represent ownership in a foreign company. They facilitate American investors' ability to invest in foreign companies through their local markets.

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American Depositary Shares (ADSs) are a type of financial instrument that represents shares in a foreign company but are traded on U.S. exchanges. They are the actual shares issued under the American Depositary Receipt (ADR) mechanism. ADSs enable American investors to invest in foreign companies without the complexities associated with trading on international markets.

Definition

American Depositary Shares (ADSs) are the individual units of ownership in foreign companies that are issued through American Depositary Receipts (ADRs). These shares represent an ownership stake in non-U.S. companies and are traded on American stock exchanges just like domestic stocks.

Mechanism and Functionality

Structure of ADSs

ADSs are created when a foreign company deposits a set number of shares with a U.S. depositary bank. In return, this bank issues ADSs that are equivalent to the value of the deposited foreign shares. The depositary bank handles transactions, dividends, and other necessary conversions.

How ADSs Work

Issuance: A foreign company partners with a U.S. depositary bank to issue ADSs. Each ADS represents one or multiple shares of the foreign company’s stock.
Trading: These shares are traded on U.S. exchanges such as the New York Stock Exchange (NYSE) or NASDAQ.
Dividends: Dividends paid by the foreign company are collected by the depositary bank, converted to U.S. dollars, and distributed to the ADS holders.
Voting Rights: ADS holders generally get the same voting rights that come with the underlying foreign shares, though voting procedures may differ.

Types of ADR Programs

Level I: These are the simplest form and trade over-the-counter (OTC). They have the least regulatory requirements.
Level II: These trade on major U.S. exchanges and comply with more stringent regulation than Level I.
Level III: These involve an IPO in the U.S. and thus adhere to the highest level of financial disclosure and regulation.

Historical Context

The concept of the ADR and subsequently ADS was introduced in the 1920s by J.P. Morgan & Co. The first ADR was created for the British retailer Selfridges and was meant to facilitate ease of investing in foreign securities by U.S. investors.

Examples and Applicability

Practical Examples

Alibaba Group Holding Limited (BABA): One of the most notable examples of a company that uses ADSs. Alibaba’s ADSs are traded on the NYSE.
Nokia Corporation (NOK): Offers its shares through ADSs, making it easier for U.S. residents to invest.

Applicability for Investors

ADSs make it simpler for investors to diversify their portfolios with foreign investments without navigating international markets, foreign currencies, and differing accounting practices.

American Depositary Receipts (ADRs)

Definition: An ADR is a negotiable security that represents one or more shares of a foreign company’s stock. ADSs are the individual securities issued under ADRs.
Usage: Both terms are sometimes used interchangeably, but strictly speaking, the ADR is the certificate, and the ADS is the share.

Global Depositary Receipts (GDRs)

Definition: Similar to ADRs, but GDRs are used to list shares of foreign companies in more than one country outside their home market.
Difference: GDRs can be traded on international exchanges, not limited to the U.S.

FAQs

What is the primary advantage of ADSs for American investors?

ADSs facilitate the ease of investing in foreign companies without having to deal with complex regulations, currencies, and markets outside the U.S.

How are dividends from foreign companies handled in ADSs?

The depositary bank converts dividends paid in foreign currency to U.S. dollars and distributes them to ADS holders.

Do ADS holders have voting rights?

Yes, ADS holders typically have voting rights, which are executed through the depositary bank in accordance with the rules of the foreign company.

Are ADSs subject to foreign exchange risk?

Yes, since the underlying assets are held in a foreign country, fluctuation in foreign exchange rates could impact the value of ADSs.

Summary

American Depositary Shares (ADSs) provide a crucial link between American investors and foreign companies, simplifying cross-border investments. By holding an ADS, investors gain access to foreign markets through their domestic exchanges, making global investing more accessible and less cumbersome. Understanding ADSs can help investors benefit from international growth while staying compliant with U.S. regulatory standards.

This comprehensive entry on American Depositary Shares (ADSs) is designed to provide you with a deep understanding of their functions, advantages, and associated considerations, ensuring you are well-equipped to make informed investment decisions.