American Depositary Receipts are an alternative to being listed in a stock exchange. They allow foreign companies to trade their stocks in the US. Foreign companies want to have their stocks traded in the US in order to increase and diversify their shareholder community. As well, being traded in the US increases their exposure to large institutional investors.
When a company does not meet the listing guidelines of the US exchanges, ADRs are the only way for them to gain access to the US market.
A company that is interested in issuing ADRs needs to approach a large American bank. The bank buys shares in the company at the company’s home stock exchange and holds them. Backed by those stocks, the bank issues tradable deposit receipts, which are listed on an American exchange.
ADRs are generally issued with a ratio of one receipt to every share of stock. However, they can be issued in any proportion. For example, one ADR may be issued for every five shares the bank holds – a ratio of 5:1. In such a case, the ADR will cost five times as much as a share of the company’s stock. The main reason for issuing ADRs at a ratio other than 1:1 is to keep their price in line with other American stocks. For example, if a US company’s stock is traded at 1 dollar per share, its ADRs would probably be issued at a 10:1 ratio, so that they will cost 10 dollars each.