The American Depositary Receipt Upsurge
The popularity of American Depositary Receipts (ADRs) is another classic example of the interaction between supply and demand in the global marketplace.
Back in 1991
when Ivey Business School Professors Steve Foerster and Andrew
Karolyi first started collaborating on research issues of mutual
interest, the market for American Depositary Receipts (ADRs)
really wasn't very big. ADRs are negotiable certificates that
represent shares of stock in a non-U.S. company and trade in the
U.S. financial markets the same way ordinary U.S. shares do. They
are the primary vehicle through which these companies list their
shares on U.S. exchanges.
Three years
later, there was a dramatic increase in the number of companies
raising capital through the depositary receipt structure. In
fact, the market for ADRs saw its best year ever. A record $20
billion was raised through depositary receipts in 1994 -- $14
billion more than in 1991.
What accounts
for the popularity of ADRs? Foerster and Karolyi, whose most
recent research project deals with the share price performance of
ADR listings in the U.S., see this growing investor appetite for
ADRs as another classic example of the interaction between supply
and demand in the global marketplace.
Investors (who
supply capital to corporations) are looking for higher returns
overseas and diversification of their risk exposures.
Corporations (who demand capital to finance their operations) are
responding by raising capital in the global marketplace the most
direct way they know how -- by listing their shares on overseas
exchanges. Companies hire the services of a depositary bank to
manage the stock transfer, and the bank creates the depositary
receipts.
"Many
people would call ADRs the innovation of the decade -- although
technically they've been around since 1927, they have been
essentially a dormant security until 1991," Karolyi says.
"Just to show you the attraction of these things, 75 per
cent of U.S. institutions that have overseas holdings basically
own ADRs -- 50 per cent of them exclusively."
Foerster and
Karolyi completed a major study, The Effects of Market
Segmentation and Illiquidity on Asset Prices: Evidence from
Foreign Stocks Listing in the U.S., this year that looked at
the economic effects of cross-border listings using depositary
receipts. They examined the listings in the United States on the
New York Stock Exchange (NYSE), the America Stock Exchange (AMEX)
and the over-the-counter (Nasdaq) market of 161 companies from 14
different countries in the Asia-Pacific, Europe and North
America. They found that the immediate effect of listing was a
very favorable 1-2% jump in the company's ADR price. However,
during the next twelve months, the average ADR price declined
about 9%, essentially erasing the initial gains and more. Even
more interesting is the fact that there are striking differences
in the post-listing returns for performance for companies listing
from different regions of the world.
What accounts
for these unusual share prices? Foerster and Karolyi don't have
all the answers yet, but they believe it has something to do with
liquidity effects, such as the way in which shares are traded and
the composition of the shareholder base. For those that increased
their shareholder base to a large extent, we saw a larger boost
in terms of their initial share price and a mitigated decline in
the post-listing period," Karolyi notes.
Another
interesting conclusion from this sample of ADR listings in the
U.S. is that the choice of depositary bank appears to make a
difference. On average, cumulative returns over the 12 months
following listing can range from as low as -9.5% for ordinary
(non-ADR Canadian) listings to as high as 7.9% for ADRs sponsored
by the Bank of New York.
"What our
findings happened to show, given our particular sample, was that
firms that use the Bank of New York as a depositary, for whatever
reason, happened to show a positive price impact post-listing
even for the subsequent one year," Foerster says.
"That's very unusual because, within the overall sample,
after the initial jump there tended to be this downward movement
in price."
Needless to say,
the Bank of New York is pleased with the findings and the
Foerster and Karolyi report has become a key component of the
bank's worldwide marketing campaign this fall.
In the meantime,
Karolyi was recently commissioned by the NYSE to write a report,
What Happens to Stocks that List Shares Abroad? A Survey of the
Evidence and its Managerial Implications, surveying the academic
evidence on the overpowering demand from major corporations
around the world to list on the NYSE. He says the report will be
used by the NYSE to try to convince the U.S. Securities and
Exchange Commission to introduce a "fast track" rule
that would lower the stringent financial disclosure requirements
for foreign companies wishing to list in the U.S.
Ultimately,
Karolyi says, the big attraction for a foreign firm in listing in
the U.S. is that the cost of raising capital will be cheaper.
"Again,
it's diversifying their risk exposure. The cost of a
corporation's capital is important when they go in and dip into
the capital markets," explains Karolyi. "How much it's
going to cost them to raise money is reflected in terms of return
and risks. The required returns are a function of their risks. If
they're perceived to be much more risky stocks, then you're going
to have to pay more to raise an amount of capital. If they're
less risky, then you'll have to pay less to raise that capital.
Of course, corporations want to pay less rather than more. With
this diversification of risk, the net impact on their cost of
capital declines."
At least, that's
the hope. In the finance field, one of the biggest unsolved
issues is how to measure the cost of capital.
"That's one
of the things that we are hoping to uncover more about,"
adds Foerster, who will be presenting the study on the
post-listing performance of ADRs at the American Finance
Association Conference in New Orleans in January. "The
answer to that question has tremendous impact for the practising
manager in Canada who is going to be faced with raising capital,
and whether to do it in Canada or elsewhere."
