Should foreign companies shy away from the U.S. market?

Essay by jimtc17University, Master'sA+, February 2006

download word file, 5 pages 5.0

The Developing countries equity markets have undergone immense changes in recent years. International investors have purchased emerging-market equity shares at exceptional rates, tripling the value of their emerging-market equity portfolios between 1989 and 1992. Bigger foreign investment in rising markets has tightened their price linkages to the international financial centers. Partly as a result of these changes, emerging markets have matured considerably, achieving increased market size and an increased capacity to support equity issuance.

A notable feature of the recent increase in equity portfolio investment in developing countries has been a large increase in international equity market placements by developing-economy companies. The vast majority of these placements have taken the form of ADRs. An ADR is essentially a claim, issued by a U.S. depository institution, to an underlying share of stock in a foreign-based company (www.citibank.com). In what is essentially a custodial arrangement, the U.S. depository institution backs the ADR by holding shares of the underlying stock on behalf of the owner of the ADR.

In exchange for a fee, the depository institution provides the service of converting dividend receipts denominated in a foreign currency into dollars and distributing them to ADR holders. Owners of ADRs are entitled at any time to redeem their ADRs for shares of the underlying stock. A particular advantage of the ADR instrument is that settlement of trades between U.S. investors can be handled by the depository institution without recourse to the home equity market of the non-U.S. company that issued the equity (www.citibank.com). In this way, the ADR mechanism avoids the risks and transaction costs associated with settlement and clearance in foreign markets.

Developing-country companies can place ADRs in the United States by two means (Greene, 2001). The first is a public ADR offering. To offer an ADR publicly in the United States,