The marginal reaction to American Depositary Receipt (ADR) issuance in emerging markets

Investors desire international diversification due to possible low correlations between international equity markets. However, barriers to investment exist causing segmented markets and higher risk premiums. American Depositary Receipts (ADRs) bypass these barriers integrating markets and reducing the cost of capital for the issuing firm. ADRs from emerging markets gradually reduce each market's aggregate cost of capital as the segmented markets become more integrated with the world market. This would suggest, at the firm level, a general pattern of a declining marginal cost of capital effect for every additional firm issuing ADRs from the same market. In other words, the reduction in the cost of capital of the firm initiating the second ADR program should be less than the reduction in the cost of capital of the firm initiating the first ADR program. Also, as more ADRs are issued from the market, existing ADRs from the market should experience a continued reduction in the cost of capital albeit at a decreasing rate. This study attempts to analyze the cost of capital effects for the marginal ADR-issuing firm as well as for firms with existing ADR programs. Specifically, the following research questions are addressed: (1a) Is the cost of capital for the issuing firm affected when an ADR program is issued? (1b) If so, does the cost of capital effect for subsequent firms issuing ADRs diminish? (2a) Is the cost of capital for existing firms with ADR programs affected when new ADR programs are initiated by other firms in the same market? (2b) If so, does the cost of capital effect for existing ADRs diminish with each additional ADR program initiated by firms in the same market?; To address these questions, a panel regression using an International Asset Pricing Model is estimated using dummy variables to identify abnormal returns around ADR listings and announcements. Additional dummy variables are used indicating the chronological order of the listings and announcements to test if the abnormal returns are affected by ADR sequence. The results show that marginal abnormal returns decrease for each subsequent ADR listing and announcement.