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American Depositary Receipts (ADR) Holdings of U.S. Based Emerging Market Funds 
 
Reena Aggarwal 
McDonough School of Business, Georgetown University 
aggarwal@georgetown.edu
Sandeep Dahiya 
McDonough School of Business, Georgetown University 
sd@georgetown.edu
Leora Klapper 
The World Bank 
lklapper@worldbank.org
Abstract 
 
The benefits of cross-listing for a foreign 
“issuer” are extensively documented in the literature, 
however it is not clear what motivates “investors” to hold American Depositary Receipts (ADRs) 
rather than the underlying stock of these issuers. We analyze the investment allocation decision of 
mutual fund managers to invest in emerging market firms that are listed in their domestic markets and 
have also issued ADRs in the U.S. Although legal provisions are typically assumed to affect ADRs 
and their underlying domestic shares equally, investors holding ADRs may have a higher level of legal 
protection as these securities are issued and traded in the U.S.  We find that ADRs are the preferred 
mode of holdings if the local market of the issuer has weak investor protection, low liquidity and high 
transaction costs, and if the firm is small and has limited analyst following.  We also find that not all 
ADR listings are associated with low liquidity in the underlying security. In fact, firms with strong 
liquidity for their underlying security are likely to be held via their underlying security rather than the 
ADRs. This suggests that ADR listings of local firms might not negatively impact local markets if the 
investment climate is good.  
 
World Bank Policy Research Working Paper 3538, March 2005 
 
The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the 
exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if 
the presentations are less than fully polished. The papers carry the names of the authors and should be cited 
accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the 
authors. They do not necessarily represent the view of the World Bank, its Executive Directors, or the countries 
they represent. Policy Research Working Papers are available online at http://econ.worldbank.org. 
 
We would like to thank Stijn Claessens and Asli Demirguc-Kunt for their comments.   
WPS3538
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ADR Holdings of U.S. Based Emerging Market Funds
 
Abstract 
 
The benefits of cross-
listing for a foreign “issuer” are extensively documented in the literature, 
however it is not clear what motivates “investors” to hold American Depositary Receipts (ADRs) 
rather than the underlying stock of these issuers. We analyze the investment allocation decision of 
mutual fund managers to invest in emerging market firms that are listed in their domestic markets and 
have also issued ADRs in the U.S. Although legal provisions are typically assumed to affect ADRs 
and their underlying domestic shares equally, investors holding ADRs may have a higher level of legal 
protection as these securities are issued and traded in the U.S.  We find that ADRs are the preferred 
mode of holdings if the local market of the issuer has weak investor protection, low liquidity and high 
transaction costs, and if the firm is small and has limited analyst following.  We also find that not all 
ADR listings are associated with low liquidity in the underlying security. In fact, firms with strong 
liquidity for their underlying security are likely to be held via their underlying security rather than the 
ADRs. This suggests that ADR listings of local firms might not negatively impact local markets if the 
investment climate is good.  
 
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2
ADR Holdings of U.S. Based Emerging Market Funds
 
1.  
Introduction 
 
It is estimated that in 2003 U.S. investors allocated eleven to twelve percent of their 
total equity portfolio to non-
U.S. equities.  Institutional investors’ purchases of foreign 
equities in 2003 amounted to $1,300 billion according to the U.S. Federal Reserve’s Flow of 
Funds.    Institutional investors are also responsible for the large interest in the trading of 
American Depositary Receipts (ADRs).  ADR programs are set up by U.S. depositary banks 
and are claims against the ordinary shares that trade in the home market as discussed in detail 
later in this paper.  In 2003, the combined dollar trading value of listed depositary receipts on 
the New York Stock Exchange, the American Stock Exchange and Nasdaq totaled $630 
billion.
1
Mutual funds such as Fidelity Management and Putnam Investment are among the 
largest U.S. investors in depositary receipts.  
U.S. investors interested in investing in a foreign firm (one based outside the U.S.) can 
do so by purchasing ADRs in the U.S., or by purchasing the underlying stock in the home 
market of the firm, or by doing both.  This paper examines the factors that affect an 
institutional investor’s choice of investment security, i.e. investing in the ADR versus 
investing in the underlying shares of an emerging market firm.  Thus, we are interested in the 
question of how a fund manager, once she has decided to invest in a company cross-listed in 
the U.S., chooses to divide that investment amount between the ADR share and the non-ADR 
shares (primarily the underlying domestic share that trades on the home stock exchange of the 
issuer) of that company.  The factors that affect fund managers’ choice of a particular firm 
1
See “Depositary Receipt Market Review 2003,” Bank of New York website. 
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3
have been addressed by Aggarwal, Klapper and Wyscocki (2004), our focus is the 
determinants of security choice (the ADR versus the underlying). 
We investigate the country and firm-level attributes associated with the decision to 
hold ADRs versus underlying (domestic) shares, or a combination of both. Coffee (1999) 
suggests that U.S. securities law provides additional protection to investors if the firm is listed 
in the U.S. and argues that firms from countries with weak shareholder protection laws can 
effectively “bond” themselves to the more stringent U.S. laws. This implies that on the 
margin, ADR holders have better legal standing compared to holders of the underlying 
security as the ADRs are purchased in the U.S. This line of argument implies that fund 
managers should prefer ADRs of firms from countries with weak legal protection for 
shareholders.  A recent example of such SEC enforcement is the case SEC brought against 
TV Azteca, a Mexican firm, in January 2005 alleging self dealing and insider trading by 
Company’s officers and Directors. Yet another example is the ability of US security holders 
of Bre-X, a Canadian mining company, to sue in a US court while the Canadian security 
holders did not get that privilege. 
However, Siegel (2004a, 2004b) using a sample of Mexican firms, finds that cross-
listing is associated with 
higher
 probability of asset stealing by controlling shareholders (thus 
causing significant wealth loss for minority shareholders). Furthermore, he reports that the 
SEC rarely prosecutes transgressions of U.S. listed foreign firms.
2
Siegel’s findings suggest 
that investors should not expect significant benefits from investing in ADRs of cross-listed 
firms as the enhanced legal protection is not significant.  This debate provides conflicting 
predictions about the effect of a country’s legal system (in particular its investor 
2
Although Coffee (2002a, 2002b) argues that while the SEC may not be a very effective enforcer, private law 
suits can still be brought against U.S. listed foreign firms, Siegel (2004a,2004b) in turn argues that the dollar 
amount of settlements in such cases is relatively small.
 
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4
protection/corporate governance laws) and a U.S. investor’s choice of investing security 
(ADR versus underlying) for cross-listed firms from that country.  The effect of local laws 
may be hard to identify, since the development of a country’s stock exchange (reflected in 
transaction costs and liquidity of that exchange) may in turn be related to the legal origins of 
that country. La Porta et al. (1997) report that, on average, countries with English common 
law origin have more developed financial markets.  Thus, to the extent that legal origin is a 
proxy for the quality of a country’s stock exchange, it may exert an additional effect 
(independent of the better investor protection effect) on the investment allocation pattern of 
U.S. investors.  
In addition to legal considerations, there are also operational issues that can be 
significantly influence a fund manger’s choice between holding the ADR or the underlying 
stock for a particular firm.  Financial institutions that offer depositary services such as Bank 
of New York, Citicorp, and JP Morgan, frequently stress the advantages of an ADR program 
for potential investors on measures such as liquidity, transparency and ease of trading.
3
Industry participants also point to the lower costs of executing trades as a major factor in their 
preference for an ADR over the domestic security, for issuers from countries with stock 
exchanges with high transaction costs. However, we are not aware of any empirical work that 
provides evidence to confirm or dispute these assertions.  This paper seeks to address this gap 
in our understanding of how professional fund managers allocate their investment between 
ADR securities and non-ADR securities. 
3
For example Bank of New York describes the potential benefits to US investors as “…While most investors 
recognize the benefits of global diversification, they also understand the challenges presented when investing 
directly in local trading markets. These obstacles can include inefficient trade settlements, uncertain custody 
services and costly currency conversions. Depositary Receipts overcome many of the inherent operational and 
custodial hurdles of international investing.”  Source:  
http://www.adrbny.com/dr_edu_basics_and_benefits.jsp
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5
Our paper also contributes to the debate on the impact of cross listing on the liquidity 
of the issuers’ shares, both in the domestic market and ADR market. A number of studies 
report that issuers who cross-list in the U.S. enjoy an increase in liquidity as measured by 
higher trading volumes or lower bid-ask spreads.
4
However other studies find that the ADR 
issuance impacts development of the local market and is associated with a reduction in the 
size, liquidity, and growth of the issuing firm’s domestic market (Karolyi 2004, Levine and 
Schmukler 2004, Claessens, Klingbiel and Schmukler 2002).  Although we do not study 
liquidity, per se, we investigate the conditions under which trading is more likely to stay on 
local exchanges.  In this regard, we find important differences between ADR investment in 
Latin America and Asia. 
Several earlier papers have examined ADRs from the issuer’s perspective focusing on 
the advantages of U.S. listing for the issuer.  Reese and Weisbach (2002) classify this 
theoretical and empirical body of work in three broad categories.  The first category consists 
of theoretical models of “market segmentation/investor recognition” which imply that when 
capital flow across countries is costly, cross-listing leads to a lowering of the cost of capital 
(thus higher equilibrium price) for the issuer (Stapleton and Subrahmanyam, 1977 and 
Errunza and Losq, 1985). Another related set of studies reports evidence supporting Merton’s 
(1987) “investor recognition hypothesis” which implies that as a firm gains recognition (e.g. 
by cross-listing abroad), the pool of potential investors also increases, resulting in the 
lowering of its cost of capital.
5
4
See, for example, Bekaert, Harvey and Lundblad, (2003), Errunza, Hogan and Hung, (2000), and Errunza and 
Miller, (2000).   
5
Miller (1999) and Errunza and Miller (2000) find empirical support for the market segmentation hypothesis.  
Support for investor recognition hypothesis is provided by  Miller (1999) (larger abnormal returns exchange 
listed ADRs compared to those that listed on the OTC market) and  Baker et al. (2002) and Lang, Lins and 
Miller (2004) who report higher analyst coverage (a proxy for higher recognition) for ADR issuers. 
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6
The second category of research papers focus on the impact of cross listing on the 
liquidity of the issuers’ shares (both in the domestic market and the ADR market).
6
Chowdhary and Nanda (1991) model trading of the same security on multiple exchanges.  A 
key result of their model is that when several markets compete for order flow of the same 
security, the exchange offering the lowest transaction costs attracts liquidity traders which in 
turn induces informed traders to also move to that exchange (in order to camouflage their 
private information). Thus, one exchange emerges as the dominant exchange in which the 
bulk of trading is concentrated.
7
This implies that for an issuer from a country with a stock 
exchange that has high transaction costs, the U.S. stock exchange (where its ADR is traded) 
may become the dominant exchange, at least for U.S. investors. This suggests that if a country 
has high trading costs (implying a relatively less liquid stock market), U.S. investors are likely 
to have a relatively larger fraction of their investment in the form of ADRs for firms from that 
country. Conversely, if the home market is deep and liquid (implying low trading costs), a 
cross-listing in the U.S. would not lower the attraction of holding the underlying.
8
The third category of recent studies has examined the benefits of listing an ADR in 
terms of better shareholder protection.  La Porta et al. (1997, 1998, 2000) show that different 
legal systems provide different levels of protection to minority shareholders with English 
common law being the most protective and French civil law being the least protective.  An 
ADR listing on a U.S. exchange may provide the ADR investor with rights that are 
6
Studies that 
report positive association between a firm’s U.S. cross-listing and the liquidity of its underlying 
include Bekaert, Harvey and Lundblad (2003), Errunza, Hogan and Hung (2000), and Errunza and Miller (2000).  
However,  Karolyi (2004) and Claessens, Klingbiel and Schmukler (2002) report contrary evidence.   
7
Lukoil, a Russian energy company, is an example of such extreme concentration in which a large proportion of 
trading takes place in the ADR. 
8
Halling et al. (2004) report that 
European 
firms cross-listed on exchanges outside their home country (U.S. as 
well as non-U.S.), foreign trading decline rapidly in the post-listing period.  Migration of trading back to home 
exchange  (“flow back”) is strongest for firms from deep and liquid home markets  that cross-list on a high cost, 
less liquid foreign exchange. Thus, they argue that unless there are compelling economies in trading costs 
(among other factors), trading tends to revert back to the home market. 
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7
comparable to those provided by a U.S. firm. An issuer from a weak shareholder protection 
legal system can therefore effectively “bond” itself to provide higher protection by listing on a 
U.S. exchange. This bonding hypothesis is discussed in Coffee (1999), and a number of recent 
studies have found some support for this argument. For example,  Doidge, Karolyi and Stulz 
(2004) find that foreign firms that list in the U.S. particularly those from countries with poor 
investor rights, have a significantly higher valuation than firms from the same country that are 
not cross-listed.  Reese and Weisbach (2002) also report a higher level of equity issuance 
(thus signifying better bonding) in the post-ADR issue period. 
Our paper differs from the studies described above on one critical dimension. While 
these studies have largely focused on the benefits to the ADR
 issuers
,
we focus on the 
motivation of 
investors
 when they choose to invest in the ADR rather than the underlying 
security. Many of the benefits of a U.S. listing that have been attributed to issuers (better 
investor recognition, higher liquidity and conformity with a more stringent legal framework) 
are equally relevant to investors.
9
For example, if holding a U.S. listed security provides 
additional legal protection, then a U.S. based-fund is more likely to hold the ADR rather than 
the underlying share for issuers based in a country with poor investor protection laws. 
Similarly, if the transaction costs/liquidity of a firm’s home stock are unattractive compared 
to those of a U.S. exchange, investors are likely to hold a larger proportion of their investment 
in the form of that firm’s ADR. The overall decision of whether or not to invest in a particular 
foreign firm has been the focus of some recent studies.
10
 
However, once a decision to invest 
9
For example, Ammer et al. (2004) report that a foreign firm can significantly increase the proportion of its 
stock held by U.S. based investors by cross-listing in the U.S.  Bradshaw, Bushee and Miller (2003) find that 
U.S. institutions invest more in non-U.S. firms that follow U.S. GAAP and that this relationship is significantly 
stronger in the subsample of firms that issue ADRs. 
10
 These papers show that both country-wide factors (such as size of the economy, shareholder rights and legal 
structure) and individual firm-specific characteristics (such as firm-size, liquidity, extent and quality of 
information disclosure) are important determinants of investment decisions for U.S. based fund managers. For 
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in a particular firm is made, not much is known about how a fund manager chooses to split 
that investment between the ADR security and the domestic security.   
The main results of our paper are the following: At the country-level, the legal origin 
of a firm’s home country is significantly related to the U.S. investors’ choice of investment 
security for that firm. On average, funds hold a significantly larger fraction of their 
investment in the form of ADRs for firms from countries of French legal origin and for firms 
from transition countries (e.g. Russia, Hungary, etc.).  These results are consistent with the 
“better legal protection” argument which implies that for issuer from weak legal systems, 
investors  prefer to hold a U.S. issued and traded ADR rather than the underlying stock.  
However, these results can also occur due to another well documented finding in recent 
studies that report that the level of a country’s stock market development (e.g. size as well as 
liquidity) is positively associated with the degree of investor protection its legal system offers.  
To isolate the effect of a country’s legal framework from that country’s stock market 
characteristics we include some direct measures of the level of stock market development 
along with legal origin variables.  On average, fund holdings of ADRs are higher for firms 
based in a country with a low level of stock market development (i.e. low stock market 
capitalization to GDP ratio or low trading volume). These results support the “ease of 
transaction” argument which implies that investors prefer to hold securities that trade on deep 
and liquid exchanges. However, the legal framework continues to be a significant determinant 
of funds’ choice of investment security even after controlling for these more specific 
measures of a particular country’s level of stock market development.  Finally, if we control 
for individual firm-specific characteristics, we find that for an issuer whose ADR security is 
more details see Aggarwal, Klapper and Wyscocki (2004), Ammer et al. (2004), and Bradshaw, Bushee and 
Miller (2003).  
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characterized by high trading volume relative to its underlying stock, the average fund 
holding is relatively higher in the ADR.  As discussed earlier, industry participants highlight 
the ease of trading as the primary benefit of holding ADRs.  Our results provide empirical 
support for this argument as the benefits of ease of trading and increased liquidity appear to 
be significant factors in an investor’s choice between the ADR and the underlying security of 
a
firm. These findings are also consistent with the theoretical predictions of Chowdhry and 
Nanda (1991) that if the same security trades in multiple markets, trading aggregates on the 
exchange with the lower trading costs.  
The remainder of the paper is organized as follows. We provide a brief description of 
ADRs and their fee structure in Section 2. Section 3 describes our main hypotheses.  A 
discussion of the data and the variables follows in Section 4. The methodology and the major 
results are reported in Section 5. We conclude in Section 6. 
2. 
American Depositary Receipts (ADRs)
 
ADRs were first introduced in 1927 and are negotiable U.S. securities representing 
ownership of publicly traded shares in non-U.S. corporations.  ADRs are quoted and traded in 
U.S. dollars on a U.S. exchange.  The dividends, if any, are also paid to ADR holders in U.S. 
dollars.  ADRs were specifically designed to facilitate the purchase, holding and sale of 
securities on non-U.S. based firms by U.S. investors.   The structure of ADRs typically 
involves a depositary bank that acquires the domestic shares in the local market (either 
directly from the company or in the local stock market) and deposits these with a custodian 
bank.  Against these immobilized local shares, the depositary bank issues depositary 
certificates for sale in the U.S.  The ADRs are then traded just like any exchange listed U.S. 
security. All ADRs are structured with a specific “bundling ratio” that denotes the number of 
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underlying shares represented by each ADR.  For Example Taiwan Semiconductor ADR has a 
bundling ratio of 1:5 which implies that each ADR represents 5 underlying shares. 
There are generally no costs for ADR to ADR trading with the depository trust 
company, which accounts for most trading of highly liquid ADRs.  The depositary bank also 
handle
s
the “cross-selling” of ADRs, which is the simultaneous buying of one security (the 
ADR, for example) and selling of the other (underlying) to exploit arbitrage opportunity. As 
described in Gagnon and Karolyi (2004) there can be significant pricing differences between 
the ADR and the underlying security although there are non-trivial trading costs that need to 
be borne to exploit these arbitrage opportunities.
11
 
An investor wishing to convert his ADRs 
into its underlying shares (or vice versa) incurs some additional costs such as conversion fee 
and foreign exchange transaction costs.  The conversion fee for ADRs is specified in the 
“Deposit Agreement” filed with the SEC for sponsored ADR programs.  These standard 
“cross-border” fees are paid to the depositary bank, and can be as high as up to $5.00 per 100 
ADRs converted. However this fee is often negotiated by brokers for shares that trade at less 
than $5.00 per 100.  Dividend fees are prohibited on NYSE ADR programs, but Level I or 
144A programs charge a standard fee of $0.02 per share. 
 
ADRs can be issued at four different levels.  Level I ADRs do not involve capital 
raising, are not offered to the public at large, and are not listed on an exchange but instead  
trade over the counter.  Level IV ADRs are issued under Rule 144A/Reg. S and are a hybrid 
of a public offering and a private placement.  Initially these issues can trade only among 
Qualified Institutional Buyers (QIBs) that have a net worth of $100 million and have 
registered broker-dealer accounts.  They trade on the PORTAL system.  These securities 
11
 Gagnon and Karolyi (2004) report that for most ADR issuers the price differences between the ADR and the 
underlying domestic security tends to be within 20 to 85 basis points although it can be as high as 66% premium 
to as low as 87% discount for the ADR relative to the domestic share. 
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allow foreign issuers to include a U.S. tranche without all the disclosure requirements. Both 
Level I and Level IV ADRs require minimal SEC registration and no additional disclosure 
other than what is required by the home country regulators.  Level II ADRs involve a public 
offering though there is no capital raising.  They trade on an exchange such as the NYSE, 
AMEX or Nasdaq and the issuer is subject to U.S. disclosure requirements.  Level III ADRs 
are issued in a public offering and new capital is raised.  The issuer must register with the 
SEC and is also subject to disclosure requirements.  Both Level II and III ADRs require 
subsequent annual filings (20-F) with the SEC and also require partial (Level II) or full 
reconciliation (Level III) with U.S. Generally Accepted Accounting Principles (GAAP). 
Furthermore, the listing exchange typically imposes listing requirements in terms of annual 
turnover, breadth of shareholder base etc. which also must be met.  Figure 1 maps the key 
disclosure requirements for different level ADRs against the ease of trading for these 
securities. 
3.  
Main Hypotheses 
Our first hypothesis examines the impact of the legal environment in a firm’s home-  
country on the relative allocation of U.S. funds’ investment between the ADR security and the 
domestic security of that firm.  We assume that a fund manager first decides whether to invest 
in a particular firm.  Once the decision to invest in the firm has been made, the manager 
decides how to allocate the investment between the ADR and the domestic security.  The 
second decision can depend on both country and firm-level factors. Specifically, the legal 
protection offered by a country may affect the attractiveness of holding the underlying 
security of a firm from that country. As previously discussed, there is a dispute in the 
literature: Coffee (1999, 2002a, 2002b) argues that a U.S. listing provides significant 
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protection to minority investors, since an ADR listing makes a firm subject to rule 10b-5, 
which gives shareholders the right to sue for losses ensued because of fraudulent statements 
made by a company whose shares they own.
12
 
On the contrary, Siegel (2004a) reports that in 
the case of Mexican firms, cross-listing in the U.S. is associated with 
higher probability 
of
asset stealing by the insiders.  He interprets these findings as evidence against the “legal 
bonding hypothesis” proposed in the literature.   These conflicting views motivate our first 
hypothesis: 
Hypothesis 1 (H1)
:
If a firm is based in a country that has poor investor protection laws, 
fund managers allocate a larger fraction of their investment in the ADR security of that 
company relative to the underlying domestic security. 
 
Our second hypothesis examines the effect of market development on ADR trading.  
As discussed earlier, countries with deep and efficient stock exchanges are better positioned 
to retain the trading volume of their cross-listed firms.  For issuers from such countries the 
ease of trading benefits arising from holding an ADR rather than the underlying stock are 
likely to be small.  On the other hand, if an issuer is based in a country that lacks a well-
developed stock market, the cost of trading the underlying stock is likely to be significantly 
higher compared to trading its ADR on a U.S. exchange. This suggests the following testable 
hypothesis: 
 Hypothesis 2 (H2)
:
If a firm is based in a country that has a less developed stock market,  
fund managers allocate a larger fraction of their investment in the ADR security of that 
company relative to the underlying domestic security. 
 
12
 Irvine (2000) describes the case of Bre-X (also discussed by Reese and Weisbach, 2002), a Canadian mining 
company that claimed (fraudulently) it had found large gold deposits causing a huge increase in its market value. 
These claims were later found to be untrue and the shareholders sued the company as the share price collapsed.  
Bre-X was cross-listed on NASDAQ and Toronto stock exchanges. The shareholders who bought the shares on 
NASDAQ were able to sue under American law but shareholders who bought in Toronto stock exchange could 
only sue under Canadian law.  
 
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We employ a number of proxies to capture country-level measures of stock market 
development, such as size of the stock market relative to the economy, liquidity (estimated as 
average turnover), settlement proficiency, and transaction costs that reflect direct costs of 
executing a trade (e.g. stamp duty, capital gains tax, broker commission, etc.).  For example, 
if higher transaction costs in the domestic security are found to be associated with funds 
devoting a larger fraction of their investment in a particular firm to that firm’s ADR security, 
it can be interpreted as support for H2. 
Our third hypothesis considers firm-level characteristics.  While factors related to an 
issuer’s home country stock exchange may have an impact on the fraction of total investment 
in that firm held as ADR, there are arguably factors that are unique to an issuer that can also 
affect the investor’s allocation decision. Specifically, while a country’s market may not be 
well-developed and may not have sufficient liquidity, an individual firm from that country 
may have fairly good liquidity for its underlying (domestic) security and large local investor 
base, making its underlying security easy to trade. For such firms, investors should hold 
relatively higher proportion of their investment in the form of underlying security.  In 
addition, relatively higher liquidity (e.g. trading volumes) of an issuer’s ADR compared to the 
liquidity of its underlying stock may make holding the ADR more attractive.   This suggests 
the following hypotheses: 
 Hypothesis 3 (H3)
:
For an ADR issuer, if the level of domestic liquidity is low, a fund 
manager is likely to allocate a larger fraction of its investment to the ADR security of that 
firm. Additionally, for firms with listed ADRs, if the relative liquidity of the ADR security 
compared to the liquidity of the underlying stock is high, a fund manager is likely to allocate 
a
larger fraction of her investment in the ADR security of that firm. 
 
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4.  
Data and Variables 
To test these hypotheses, we create a unique database using a number of data sources.  
Our primary data source is the February 2002 edition of the Morningstar database for each 
U.S. mutual fund with a stated objective of investing primarily in emerging market equities.
13
 
All of the sample funds are primarily equity funds with more than 90 percent of their 
investment in equities.  We include three classifications of U.S. mutual funds: Diversified 
Emerging Markets, Pacific/Asia excluding Japan, and Latin America.  We exclude 
Diversified Pacific/Asia mutual funds because the majority of their investments are in 
countries that are not considered emerging markets, such as, Japan, Hong Kong and 
Singapore.  Similarly, we exclude European funds because of their emphasis on developed 
Western European markets.  In the Pacific/Asia excluding Japan sample of funds, we exclude 
11 funds that invest 90 percent or more of their assets in 3 or less countries.  We also exclude 
multiple classes of the same emerging market mutual fund.  Certain funds have multiple 
classes that have identical portfolio holdings but different fee structures.  For example, one 
fund may have an exit fee but the other does not.  Finally, since our analysis focuses on active 
portfolio allocation decisions of U.S. mutual funds, we also exclude exchange-traded funds 
and funds that explicitly follow passive indexing strategies. Our final sample consisted of 111 
funds consisting of the three categories; Diversified Emerging (73 funds), Latin America (14 
funds), and Asia (24 funds). The country level data is taken from various sources including 
Datastream, IMF and La Porta et al. The data for individual firms is obtained from 
Worldscope, Datastream, Bloomberg and hand collected data from 20-F filings.   
13
 Consistent with the MSCI Emerging Markets Free Index, we define the following 30 countries as emerging 
markets: Argentina, Brazil, Chile, China, Colombia, Czech Republic, Egypt, Ghana, Greece, Hungary, India, 
Israel, Jordan, Malaysia, Mexico, Morocco, Pakistan, Peru, Philippines, Poland, Russia, Slovakia, South Africa, 
South Korea, Sri Lanka, Taiwan, Thailand, Turkey, Venezuela and Zimbabwe.   
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Appendix A provides a detailed description of all the variables. Appendix B provides 
key country-level statistics.  Shareholder Rights are generally highest for English legal origin 
countries such as India, Pakistan and South Africa and lowest for French legal origins 
countries that include Mexico and Venezuela.  Market development as measured by market 
capitalization/GDP is highest for South Africa, Malaysia, Taiwan and Chile.  Korea and 
Taiwan are some of the largest and most liquid markets.  There is not much variation in 
settlement proficiency with most countries receiving the highest possible score of three.  
However, there is considerable variation in transactions cost efficiency with only four 
countries receiving the highest score of three.  Appendix C provides correlation measures of 
various firm-level characteristics. In the following section we describe how our principal 
dependent variables are constructed.   
4.1  
Dependent Variables - Measurement of Allocation Choice 
One of the primary goals of this research is to examine factors that determine how the 
total investment in a firm is divided between that firm’s ADR and its underlying security.   
Thus we need to construct meaningful measures of what constitutes this relative 
“over or 
under weight”
 in the ADR relative to the underlying.  Our primary measure for this allocation 
choice is “
ADR Differential”. 
 This is constructed using the Morningstar database described 
above. For each firm 
i
,
we first identify all funds that hold an investment in that firm. This 
investment can be either in ADRs, in the underlying domestic security or in both.  For 
illustration let us assume that there are 
k
funds that hold an investment in firm 
i.
 To estimate 
the relative weighting of investments in ADR versus the domestic security for this firm we 
follow a two step process. In the first step, for each fund 
k
we calculate the total dollar amount 
of investment (sum of investment in ADR and underlying) in firm 
i, 
that a fund holds. We 
Page  17
16
then calculate the fraction of that investment in the ADR and the fraction in the underlying for 
that fund. Next, we take the difference between the fraction of investment in the ADR versus 
the domestic stock. This difference reflects the relative over or underweighting in ADR for 
that fund.  We repeat this process for all of the 
k
funds, thus generating the relative over or 
under allocation of investment in ADRs for each fund. In the second step, we take a simple 
average of these 
k
values to get the aggregate measure of over/underweighting across all 
funds that invest in the firm 
i
and denote it by (
ADR Differential).  
 
This process can be 
described by the following equation: 
 
We also create an alternative measure of 
“over or under weight”
 in the ADR denoted 
by 
“ADR_RATIO”
.
For a particular issuer 
i
,
the 
ADR_RATIO
 is also calculated in two steps. 
First, the total value of (U.S. dollar amount) of investment by all funds in that firm is 
calculated.  This calculation includes all securities issued by issuer 
i
(for most issuers it is the 
ADR and the underlying security of that issuer).  The second step involves calculating the 
total investment by all funds in the ADR security of firm 
i.
 
ADR_RATIO
 is calculated by 
taking the ratio of investment in ADR security of firm 
i
by all funds to the investment in all 
securities of firm 
i
by all funds. Equation 2 describes the calculation of 
ADR_RATIO
 below: 
 
(_
)
1
(_
)
=  
  
  
  
   
 
    
 
   
  
 
   
 
    
 
   
  
  
   
 
   
 
   
  
  
   
 
    
 
   
  
 
    
   
(1)
Where (
_
)
 denotes fund  's over or underinvestment in f
k
k
ADR
Differential
i
n
ADR
Differential
i
k
k
ADR
Differential
k
i
å
=
irm  's ADR and is estimated as
(
_
)
 = (Fraction of investment held in ADR ) - (Fraction of held in undelying) 
i
k
ADR
Differential
i
(Total $ amount invested in ADR security of firm   )
1
(_
)
=  
 
      
(2)
(Total $ amount invested in ADR security and domestic security of firm   )
1
k
k
i
i
n
ADR
RATIO
i
k
k
i
i
n
å
=
å
=
Page  18
17
We use the example of Telefonos de Mexico (Telmex), a Mexican 
telecommunications firm to illustrate how the 
ADR_Differential
 and the 
ADR_RATIO
 are 
calculated for this firm. Telemex is held by 79 funds and the total investment in this firm is 
$363 million. Of this $363 million, $344 million is held as ADRs and $19 million is held as 
the underlying security. Thus, 
(ADR_RATIO)
Telmex
 equals 0.94 ($344/$363). For calculating 
(
ADR Differential
)
Telmex
 we need to calculate the difference in the fraction of investment held 
in ADR and the fraction of investment held in the underlying for each fund. Of the 79 funds, 
70 hold only the ADR. Thus the ADR differential for each of these funds is 1 (fraction held in 
ADR 
–
fraction held in underlying). 7 funds hold only the underlying which implies that ADR 
differential for each of these funds is -1. Remaining two funds hold both ADR and underlying 
of Telmex, with ADR differential of -0.94 and 0.15. The calculation of (
ADR 
Differential
)
Telmex 
is as follows: 
 
The example of Telmex also illustrates that a predominant fraction of funds (70 out of 
79) invest in Telmex through its ADR.  In other firms the opposite is true, i.e. most funds hold 
only the underlying security rather than the ADR. For example, consider the case of 
Advanced Semiconductor, a Taiwan-based semiconductor fabricator. There are 16 funds that 
hold a total of $8.2 million in this firm and of which only $0.1 million is held in the form of 
the ADR.  Of the 16 funds, 14 hold only the underlying and one fund holds only the ADR 
while one fund holds both.  For Advanced Semiconductor the 
ADR_Differential
 and 
ADR_RATIO
 are -0.83 and 0.01 respectively.  These examples highlight an interesting feature 
of ADR holding patterns observed in our sample.  For a typical issuer, any single fund 
(70
7
0.15
0.94)
(
_
)
=  
 = 0.787 
79
ADR
Differential
Telmex
-+
-
Page  19
18
typically either holds only the ADR or holds only the underlying. Figues 2 and 3 illustrate this 
propensity of funds to favor either the ADR or the underlying.  Figure 2 provides a frequency 
distribution of the 111 funds’ holding ADR holdings pattern. Of the 136 listed ADR issuers, 
in 38 cases every fund that invests in these firms invests 
only in the underlying shares
 of
these 
firms.  For 22 firms all the funds that invest in these firms hold 
only
 
the ADR.
 
Thus for nearly 
half of the sample of ADR issuers the fund holding is 
exclusively
 in either the underlying or 
the ADR.  Figure 3 plots the number of firms against the aggregate dollar amount invested by 
funds in the ADR of these firms. Again, we observe the same concentration of investment in 
either the ADR or the underlying.   At the individual issuer level this pattern of strong 
preference of either the ADR or the underlying is clearly evident, however we find that at the 
fund
 level there are no clear preferences for holding ADRs or the underlying local shares. We 
do not, for example, find funds that specifically invest only in ADRs.  Most funds hold both 
underlying and ADR securities. The average and median percent holdings of ADRs across 
funds is 29%, with a standard deviation of 10%.  These summary statistics suggest that a 
funds decision to hold ADRs versus underlying shares is influenced by country and firm level 
characteristics. 
Our finding that most funds hold primarily the ADRs or underlying shares of specific 
firms motivated us to construct an alternative measure of a fund’s preference for a firm’s 
ADR versus its underlying security.  This is a binary variable 
(ADR_OverWeight)
i
which 
equals one if at least 50% of all funds that invest in firm 
i
invest only in its ADR (and zero 
otherwise). Hence, 
(ADR_OverWeight)
i
captures the aggregate fund choice of investment 
security for firm 
i
.
Thus for Telmex,
 ADR_OverWeight
 equals 1 while for Advanced 
Semiconductor the value is zero. 
Page  20
19
4.2  
Sample Descriptive Statistics 
Panel A of Table 1 shows that the portfolio holdings of Asian and Latin American 
firms show different patterns. Funds invest in 31 percent of non-ADR firms in Asia as 
compared to only 19 percent in Latin America.  Of all the Asian firms with an ADR program, 
65 percent are held by at least one fund. For Latin America the corresponding number is 73 
percent.  Panel B of Table 1 reports the same pattern when the market value of firms is used 
instead of number of firms. It shows that of the Latin American firms covered by Worldscope, 
those that have an ADR represent 66 percent of that region’s market capitalization. However, 
Asian firms with ADRs represent only 43 percent of that region’s market capitalization. 
Several conclusions can be drawn from this analysis. For the universe of firms covered 
by Worldscope: 1) A larger proportion of Latin American firms issue ADRs than Asian firms; 
2) Funds are more likely to hold positions in firms that have ADRs; and 3) Funds are more 
likely to invest in non-ADR firms from Asia than non-ADR firms from Latin America (this 
may reflect the fact that Latin American firms are almost two times more likely to have ADRs 
than are Asian firms).   
5. Empirical 
Results 
This section describes the methodology employed to test the hypotheses discussed in 
section 3 and reports our major findings. 
5.1  
Differences between Latin America and Asia 
Most emerging markets have some ADRs listed in the U.S.  The fraction of ADR 
listings is particularly high for Latin America as seen in Table 2.  For example, 20 percent of 
all Mexican firms (covered by Worldscope) have a listed ADR.  The corresponding numbers 
are 14.29 percent, 7.55 percent and 10.92 percent for Argentina, Brazil and Chile, 
Page  21
20
respectively.  Often, it is the largest firms in a country that issue ADRs.  These firms represent 
a
large proportion of the market capitalization of each country’s stock exchange.  In the case 
of Argentina and Brazil, firms with ADRs make up more than 50 percent of the country’s 
market capitalization.  For most Asian countries the proportion of firms with listed ADRs is 
small and varies between one to three percent.  Even though the fraction of Asian firms that 
have an ADR program is small, these few firms account for a fairly large proportion of total 
market capitalization.  For example, the fraction of market capitalization of ADR firms is 42 
percent for China, 41 percent for Korea and 34 percent for India.   
Table 3 provides some descriptive statistics on the average holdings of the 111 mutual 
funds studied.  The 73 diversified firms are on average larger with an average portfolio 
market value of $124 million. These are followed by the 14 Latin American funds at $65.6 
million, with Asian funds being the smallest at $42.7 million.  On average, a fund invests 25 
percent of its assets in ADRs (both listed and unlisted), with the remaining 75 percent being in 
domestic stocks.  The proportion of holdings in unlisted ADRs is small, on average ranging 
from 0.1 percent of a fund’s assets for Asian funds to 6.6 percent for Diversified Emerging 
Market funds.   The proportion of investment in unlisted ADRs is low on average but can be 
extremely high for certain countries.  For example, there are 73 Diversified Emerging Market 
funds in our sample and 64 of these invest in Russia.  On average, 67 percent of their assets 
are invested in unlisted ADRs.   
 Latin American funds have a far greater fraction of their investment in ADR 
securities compared to Asian funds.  Latin American funds invest more than 45 percent of 
their assets in ADRs and the remaining 55 percent in domestic stocks.  However, Asian funds 
invest less than 13 percent of their assets in ADRs with the remaining 87 percent being 
Page  22
21
invested in the domestic security.  The large variations in ADR investments are also seen at 
the country-level in Panel B of Table 3.  For example, fund investments in Chilean companies 
are concentrated in ADRs but in the case of Korea the investment is in domestic shares.  We 
next analyze the country and firm attributes that determine whether a fund invests in the ADR 
or the domestic stock.  U.S.-based emerging market mutual funds invest in a total of 1,361 
firms: 136 firms have listed ADRs, 251 have unlisted ADRs and 974 firms do not have an 
ADR as shown in Table 4.  The 136 firms with listed ADRs are, on average, larger as 
measured by market capitalization and book value of total assets, and have a higher market to 
book ratio than firms with unlisted ADRs or no ADRs.  Firms with unlisted ADRs are, in 
turn, larger and have higher market to book ratio than firms with no ADRs.  
5.2  
Legal Environment and ADR Investment 
Our first objective is to determine the impact of country-
level attributes on the funds’ 
choice of investment security for ADR issuers from that country (see H1).  As we discussed 
earlier, if U.S.-based investors feel that holding an ADR confers additional legal protection to 
them (Coffee 1999, 2002a, 2002b), they would prefer holding the ADRs to the underlying 
(especially for firms from countries with poor investor protections laws). In H1 we are 
interested in measuring the relationship between the investor protection/corporate governance 
laws of an issuer’s home country and the investment allocation decision of a U.S. investor. A 
number of recent studies show that the legal origin of a country and the quality and 
enforcement of investor protection laws are closely related.
14
 Common law (English) 
14
 Denis and McConnell (2002) define corporate governance as the set of mechanisms designed to induce 
managers to make decisions that maximize shareholders' wealth and to deter managers from expropriating 
shareholder wealth. La Porta et al. (1997, 1998, 2000) discuss the role of strong investor protection laws and 
enforcement in fostering corporate governance that protects and attracts outside investors. Their empirical results 
show that better investor protection laws and law enforcement institutions are associated with more developed 
capital markets. The quality of information provided to outside investors is also higher in countries with strong 
investor protection (see, for example, Leuz, Nanda, and Wysocki, 2003). 
Page  23
22
countries offer the strongest investor protection while civil law (French) countries offer the 
weakest investor protection.  The investor protection offered by a country’s laws may have an 
impact on an investor’s portfolio allocation decision across firms from countries with 
different legal systems. However, once a fund manager has chosen to invest in a particular 
firm, the legal environment or shareholder protection laws of the country in which that firm is 
based should not influence how much of that investment is in the form of that company’s 
ADR versus its underlying domestic security, if both the ADR holder and the holder of the 
domestic security have similar rights. For example, an investor holding an ADR of a Brazilian 
firm typically does not have any voting rights. However, the underlying security (typically a 
preferred share) also lacks these voting rights.  In contrast, an investor in a Taiwanese firm 
has voting rights regardless of whether he holds the ADR or the underlying. While this may 
make investment in a Taiwanese firm more attractive, there would be no compelling argument 
as to why an investor would prefer the ADR over the domestic security (or vice versa) in 
either country if the ADR and the underlying offered exactly the same benefits.   In such a 
case we should expect to see no relationship between a country’s legal origins and relative 
fraction of investment in ADRs of firms from that country.  However, as we discussed earlier, 
if U.S. based investors perceive that holding an ADR confers additional legal protection to 
them (Coffee 1999, 2002a, 2002b), they would prefer holding the ADRs to the underlying 
(especially for firms from countries with poor investor protections laws).  
To test these arguments we estimate the following model: 
 
The variables for equation 3 are discussed below: 
01
2
3
45
 ( 
 
)
(
)
(
)
 
+(
)
(
 
)  
  
 
 
(3)
ADR Differential
GDP Per Capita
French
German
Transition
Shareholder Rights
bb
b
b
bb
=+
+
+
+
Page  24
23
 
·
ADR Differential
:
An aggregate measure of over or under investment in the ADR security 
of firm 
i
as described in equation 1 and as discussed in Section 4.1.  
·
Legal Origin Dummy Variables
:
A
dummy variable that identifies the legal code of the 
country as common law (
English
), civil law (
French
), or Germanic (
German
)
as described 
by La Porta et al. (1998).  We also include an additional dummy for the formerly Soviet 
Union block countries (
Transition
).   
·
Shareholder Rights
:
This variable measures the “anti-director rights” index originally 
developed by La Porta et al. (1998) and was subsequently updated by Pistor (2000) to 
include transition emerging markets. It is the sum of dummies identifying one-share/one 
vote, proxy by mail, unblocked shares, cumulative vote/proportional representation, 
preemptive rights, oppressed minority, and percent of shares needed to call a 
shareholders’ meeting.  
·
GDP per Capita
:
This serves as a control variable for the level of economic development 
of the economy.   
 
By construction 
ADR Differential
 is
 
restricted to lie between -1 (when all firms invest 
only in the domestic security) and +1 (when all firms invest in the ADR). Thus our dependent 
variable is truncated in both the left and the right tail.  We report the results for an OLS model 
as well as for a Tobit specification where the dependent variable is constrained to lie between 
-1 and +1.
15
 
The analysis covers the 387 firms that are held in at least one fund’s portfolio and that 
have an ADR issued (listed or unlisted) at the beginning of 2001.  A fund manager thus has 
the option to invest in only the ADR, only the underlying domestic stock, or a combination of 
the ADR and the domestic stock for these firms.   Each model is first estimated for all firms 
that have issued an ADR (listed or unlisted). To better isolate the effects of a liquid and easily 
traded ADR, we also estimate each model for the subset of firms that have a listed ADR.  The 
15
 We also estimated the same model using 
ADR_RATIO
 and 
ADR_OverWeight
 as the dependent variable.  
ADR_RATIO
 is calculated by dividing the total dollar amount of investment (across all funds) in the ADR 
security of a company 
i
by the total dollar investment (across all funds) in all securities (ADR and non-ADR) of 
company 
i.
 
ADR_OverWeight
 is a binary variable that equals 1 if at least 50% of all funds that invest in a 
company only invest in its ADR.  The results for these alternative proxies for choice investment security are very 
similar to those reported for 
ADR_Differential
 and are available on request from the authors. 
Page  25
24
first model includes 
GDP per Capita 
and legal origin as the explanatory variables as reported 
in Table 5.  We include dummies that identify the legal code of the country; the common law 
(
English
)
dummy is left out and serves as the benchmark.  In the second model, 
Legal Origin
 
is replaced by 
Shareholder Rights
.
Table 5 reports the results of the country-level estimations. Panel A reports the results 
for the OLS regression while Panel B reports the results for the Tobit regression. The results 
are essentially similar in both specifications.  We find that 
Legal Origin-French 
is positive 
and significant in both models and 
Legal Origin-Transition 
is positive and significant for 
listed ADR sub-sample.  Our results suggest that in non-English legal systems fund managers 
invest more in the ADR than the domestic stock.  
Shareholder Rights
 is not significant in any 
of the models.  If for a firm its ADR holders and underlying security holders have exactly the 
same rights it would imply that legal origin and shareholder rights by themselves should not 
matter.  However, as discussed earlier in the introduction section, US investors may perceive 
that ADRs offer better legal protection compared to holding the underlying especially if the 
issuer is based in a country with weak investor protection/corporate governance laws. It is 
also possible that legal origin is a proxy for market development that could be important in 
determining the allocation between the ADR and the domestic security.   
5.3 
Stock Market Development and ADR Investment 
Next, we attempt to examine the role of market development in explaining a fund 
manager’s decision to invest in the ADR versus the domestic stock (See H2). However, legal 
origin and investor protection laws are also associated with degree of development of 
financial markets. Beck, Demirguc-Kunt and Levine (2002) conclude that well-functioning 
legal systems that defend the rights of individual investors are important for stock market 
Page  26
25
transactions.  LLSV (1998) find that a country’s legal origin is important in explaining the 
country’s laws on creditor rights, shareholder rights, and private property rights and also a 
country’s level of market development.  They argue that legal origin matters for financial 
development because some legal traditions are able to adapt more efficiently to evolving 
economic conditions.  To the extent that legal origin might serve as a proxy for capital market 
development it would also affect a fund manager’s decision to invest in the ADR versus the 
domestic stock. Therefore, we use more direct measures of market development and 
transaction costs in addition to legal origin as explanatory variables. Specifically, we estimate 
the following model: 
 
Equation 4 is an expanded version of equation 3. We use direct measures of market 
development and transaction costs in addition to legal origin as explanatory variables. We 
include the ratio of market capitalization to GDP (
Market Cap/GDP) 
as a
 
measure of the 
overall size of the equity market relative to the size of the economy.  Liquidity of an exchange 
is critical for institutional investors and we estimate the average daily turnover (
Turnover 
Country) 
for the domestic stock exchange and include it as an explanatory variable
.
We also 
include a direct measure of transaction costs (
Transaction Efficiency
).   The score on this 
variable ranges from one to three and is obtained from Wilshire Consulting Group’s report for 
California Public Employees' Retirement System (CALPERS).  A higher score implies lower 
transaction costs and therefore higher efficiency.  Transaction costs are associated with 
trading in a particular market and include items such as stamp taxes and duties, amount of 
dividends and income taxed, and capital gains taxes.  Countries such as Brazil and Mexico 
0
12
3
45
6
(
)(
)
(
 )
+(
 )
(
 ) 
(
 
)
ADR Differential
GDP Per Capita
MarketCap GDP
T
urnover Country
Transaction Efficiency
Settlement Efficienc
y
FX Volatility
bb
b
b
bb
b
=+
+
+
++
78
9
 
()
(
)+
(
) 
      
      
      
      
      
 
(4)
French
German
Transition
bb
b
++
Page  27
26
have the highest transaction efficiency (lowest costs) with a score of three.  The countries 
with the lowest score on transaction efficiency include Chile, China, Colombia and Indonesia.  
Similarly, we also include a settlement proficiency variable (
Settlement Proficiency)
 from the 
same report for CA
LPERS.  This variable captures whether or not a country’s trading and 
settlement is automated and measures the success of the market in settling transactions in a 
timely manner.  A score of one to three is assigned for each country - a higher score indicates 
a
more efficient settlement system. Most emerging market countries with large market 
capitalization have a score of three.  The exceptions are India, Russia and South Africa, which 
have 3- to 5-day settlement windows.   
We also include 
FX Volatility
,
to control for the likelihood of exchange rate 
depreciation. ADR share prices carry the same foreign currency risk as underlying shares and 
most ADRs trade in line with the underlying security. The spread is generally very small, 
reflecting the cost of foreign exchange conversion and other execution costs. If the currency 
of the underlying stock rises against the US dollar, the ADR price is expected to rise (and vice 
versa).  Dividends are converted and paid in US dollars.   
Our results are reported in Table 6: Panel A reports the results of an OLS regression 
while Panel B reports the estimates of the Tobit regression. Again the results are broadly 
similar across the two specifications. In the first model we only include 
Market Cap/GDP 
and 
Turnover Country 
in addition to 
GDP per Capita
.
The model is estimated for all ADRs and 
for only listed ADRs.  The coefficient on 
Market Cap/GDP
 is significant and negative for the 
entire sample and for the sub sample of listed firms it is negative but not significant
.
The 
results suggest that fund mangers allocate a relatively smaller proportion of their investment 
in particular firm’s ADR security if that firm’s domestic market is well developed (as 
Page  28
27
measured by 
Market Cap/GDP)
.
The coefficient on 
Turnover Country
 is negative and 
significant in both models. Thus if a firm is based in a country with  domestic markets that are 
deep and liquid, the fund holdings of ADRs of such a firm is relatively low. This provides 
empirical evidence support for market microstructure models of multiple exchanges 
(Chowdhary and Nanda (1991)) that predict that informed traders (assuming the active mutual 
fund investors of our sample can be considered informed traders) choose to trade in markets 
that have the highest liquidity.
16
 
These results suggest that countries with high turnover 
appear to retain the order flow of their ADR issuers in the home market.  Conversely, the 
results imply that professional investors are more likely to invest in the ADR relative to the 
domestic stock if the issuer’s home country’s stock market is not well developed and has low 
liquidity.   
Earlier we discussed the results of previous studies that have documented the 
association between market development and legal origin.  It is possible that our earlier 
results, showing significant association between a country’s legal origin and fund managers’ 
ADR vs. domestic security allocation decision were likely being driven by market 
development as the legal origin dummy variable was capturing the effect of how developed 
the country’s stock market is.   To test this alternative explanation, in the second set of models 
in Table 6 , we include market development variables (
Market Cap/GDP 
and 
Turnover 
Country
), 
FX Volatility,
 and 
Legal Origin 
dummies.  We also include 
Settlement Proficiency 
and 
Transaction Efficiency
 to capture the cost of trading in the domestic market.  We find that 
the market development attributes are no longer significant.  However, 
Transaction Efficiency
 
is negative and significant in two of the three models at the 1 percent level.  The results imply 
16
 The informed traders are drawn to the most liquid markets as they can conceal their (informed) trade better in 
a
market where trading activity is high. 
Page  29
28
that if the cost of executing transactions is high in the domestic market, funds are more likely 
to invest in the ADRs of firms from that country.  The 
French Legal Origin 
continues to be 
positive and significant in the model both with all ADRs and with only listed ADRs.  
Transition
 
Legal Origin
 is also significant for listed ADRs.  Therefore, the results suggest that 
the legal system captures more than just market development.  It is also interesting to note that 
the R
2
increases from 0.09 to 0.17 for all ADRs and from 0.04 to 0.20 for listed ADRs from 
the reduced model with only market development variables to the full model that also 
includes legal origin and transaction efficiency.   
To summarize, funds are likely to allocate more funds to the ADR than the domestic 
stock in countries that have non-English legal origin, particularly in ADRs of firms from 
French legal origin and from former communist block (Transition).  It is possible that legal 
origin might simply be capturing market development.  We do find that funds are more likely 
to allocate more funds to the ADR than the domestic stock in countries that have less 
developed stock markets, low liquidity and high costs of trading.  These results are consistent 
with the commonly cited explanation by industry professionals which argues that transaction-
related factors play an important role in the choice of a firm’s ADR security over the domestic 
security for an investor.  However, legal origin continues to be important even after 
controlling for these factors.  Investors allocate more funds to the ADR of a firm if that firm is 
based in a country with French legal origins or if it was a former communist bloc country.
 
5.4  
Firm-Level Attributes and ADR Investment 
We next extend our analysis to firm-level attributes. If the liquidity of an underlying 
security is high in the domestic market of the issuer, the investor’s incentive to hold the firm’s 
ADR should be lower (see H2). Also for firms with ADRs, if the liquidity of the underlying 
Page  30
29
security is low compared to the liquidity of its ADR, funds are expected to hold a higher 
fraction of their investment in that firm in the form of ADRs (see H3).  To examine the impact 
of these liquidity measures on the funds’ investment allocation between the ADR and the 
domestic security we estimate a model of the following form:
 
Equation 5 is based on the specification used to measure the impact of country level 
factors on the 
ADR_Differential
 (equation 4). In addition to the country characteristics we 
now include the following variables: 
 
·
Liquidity-Underlying: 
This is the ratio of the daily average volume of underlying traded 
(for 2001) to average number of underlying outstanding (simple average of 2000 and 2001 
reported numbers). The data is obtained from Datastream.
 
·
Liquidity-Relative
:
This is calculated by dividing the average daily trading volume of 
ADRs (converted into the equivalent underlying by using the ADR to underlying ratio) to 
the average trading volume of the underlying. Thus a high value for Liquidity-Relative 
implies that the ADR security is more liquid than the underlying. The trading volume data 
is obtained from Bloomberg. 
 
While intuitively straightforward, data collection on each of these liquidity variables 
posed some special challenges. The underlying security is not always the common stock. 
Issuers from Brazil and Mexico almost always have multiple classes of shares. For example, 
Brazilian firms issue ADRs that have preferred shares as the underlying security.  The 
preferred share is the main security for domestic investors, while the common stock is held 
01
2
3
45
6
7
 ( 
 
)
(
 
 
)
(
 
)
 
()
(
-
)
(
  
) 
+ 
()
ADR Differential
Log Market Cap
Number of
Analysts
Accounting Quality
Liquidity
Underlying
Liquidity Relative
GDP P
er Capita
MarketCap GDP
bb
b
b
bb
b
b
=+
+
+
+-
+
+
89
10
11
12
13
14
 
(
)+
(
 )
(
 ) 
 
(
)(
)
(
)+
(
)   
  
     
 
Turnover Country
Transaction Efficiency
Settlement Efficiency
FX Volatility
French
German
Transition
bb
b
bb
b
b
++
++
+
 
(5)
Page  31
30
mostly by a small group of insiders.
17
 
To identify the class of security that is underlying the 
ADR, we read through 20-F filings, which are mandatory SEC filings of listed ADRs. Also, 
while the ADR Ratio is usually reported by major databases (e.g. Datastream, Compustat and 
BONY website), it requires adjustment for some of the issuers that have ADR ratios greater 
than 1,000.  In such cases the underlying secu
rity’s trading volume is reported in units of 
thousands and to convert the ADR trading into equivalent underlying trading volume this 
convention needs to be accounted for.  
The liquidity estimation process is illustrated by using the example of Videsh Sanchar 
Nigam Limited (VSNL), an Indian firm. For the year 2000-01, the average number of shares 
outstanding for VSNL was 28,500,000.  On the Bombay Stock Exchange, the average daily 
trading volume (in 2001) of VSNL’s underlying shares was 352,500 shares. Thus the 
Liquidity-Underlying 
for VSNL is 0.0124 (352,500/28,500,000). Furthermore VSNL has 
issued an ADR that is listed on the NYSE. One VSNL ADR provides the holder a right to 
own two underlying shares. The daily ADR trading volume on the NYSE for VSNL is 
183,090 ADRs.  This is equivalent to 366,180 underlying shares.  The 
Liquidity-Relative
 for 
VSNL is thus 1.0388 (366,180/352,500).   
We also include a number of other firm-specific characteristics.
18
 
17
 Voting rights (and dividend rights) for holders of preferred shares are severely limited. Similarly, Mexican 
firms have many different classes of stocks and typically have a complex underlying security (usually referred to 
as a CPO or a unit) that is a bundle of different classes of stock (e.g. Grupo Televista has an ADR on an 
underlying CPO that represents 1 A Share, 1 L Share and 1 D Share). Also some firms have multiple ADRs 
based on multiple underlying stocks in Mexico (e.g., Telefonos de Mexico, America Movil, Transport Maritima 
Mex) and Chile (e.g. Sociedad Quimica, Embotelladora Andina). All Chinese ADRs are based on H class shares 
(different from domestic class shares which can only be held by Chinese investors) which trade on the Hong 
Kong stock exchange. 
18
 Previous literature has shown a positive relationship between better firm-level attributes and financial and 
equity performance in developed and emerging markets (see, for example, Gompers, Ishi and Metrick, 2003, and 
Klapper and Love, 2003). 
Page  32
31
·
Log Market Cap:  
Natural log of market capitalization of the issuer in US dollars as 
reported by Worldscope.
 
·
Number of analysts: 
As reported by I/B/E/S. 
·
Accounting Quality: 
We create an index of firm-level accounting quality (Accounting 
Quality) which equals the sum of the four separate accounting quality variables: Use of an 
international Big-5 accounting firm, consolidation of financial reports, receipt of a clean 
audit opinion, and reconciliation with either U.S. GAAP or International Accounting 
Standards. 
19
 
Table 7 reports the estimated models for 1) All ADRs, and 2) Listed ADRs both for 
the OLS regression (Panel A) and for the Tobit regression (Panel B).   Two models are 
estimated. The first includes only the firm-level attributes discussed above and the second 
includes both firm-level and country-level attributes.  We find that, holding all else constant, 
higher liquidity of a firm’s underlying stock is negatively associated with the fraction of 
investment held in the ADR of that firm.  This is consistent with the ease of trading arguments 
and theoretical models that predict that informed traders would tend to concentrate in the most 
liquid markets.  This finding is strongly supported when we run the regression for the sub-
sample of firms that have listed ADRs.  Here we can use a more direct measure of liquidity 
differences between a firm’s ADR and its underlying security by including the 
Liquidity-
Relative
 variable.
 20
 
The coefficient on this variable is positive and significant at the one 
percent level across all specifications. These findings provide robust evidence that fund 
manager’s choice of security is significantly affected by the relative liquidity of the two 
securities. Thus, the mere act of listing an ADR need not move the trading volume from 
19
 Mitton (2002) finds that higher firm-level disclosure quality had a strong impact on firm performance during 
the East Asian financial crisis. Related studies also find that firms with ADRs appear in better information 
environments that are then associated with higher market valuations and significantly larger market reactions to 
earnings announcements (for example see, Foerster and Karolyi, 1999, Lang, Lins and Miller, 2003, and Bailey, 
Karolyi, and Salva, 2002, Doidge et al., 2004). See Karolyi (1998) for an excellent review of the ADR literature. 
20
 We also used an alternative proxy for relative liquidity denoted by ADR Fraction which is the fraction of the 
underlying security that is in form of ADR. The results very similar to those for Relative Liquidity and are not 
reported. These results are available from authors on request. 
Page  33
32
domestic market to the U.S. market if the domestic markets are deep and liquid..  For 
example, Kookmin Bank, a large South Korean bank has a listed ADR (each ADR represents 
1
underlying share) and is held by 67 funds. The average daily volume for the underlying 
stock is 2.7 million while for the ADR it is only 0.14 million shares.  Transaction costs at the 
country-level continue to be an important factor in deciding whether to invest in the ADR or 
the domestic stock. Settlement efficiency, however, is no longer a significant factor in funds’ 
allocation between ADR and domestic security for the sub-sample of listed ADRs.  Finally 
legal origin continues to be significant for issuers from French legal system countries.  The 
positive and significant coefficient implies strong funds’ preference for holding ADR 
securities of issuers from French legal system countries. 
6. 
Summary and Conclusions 
In this paper we review the firm, country, and market characteristics that are related to 
a
fund manager’s choice to hold an ADR security versus the domestic security of emerging 
market firms.  We specifically examine this allocation decision for firms that have both an 
ADR and a domestic security trading, therefore providing a fund manager the choice of 
whether to invest in the firm by investing in the ADR or the underlying domestic stock.  We 
find that country-level institutional factors, such as legal origin, are significant in explaining 
the fund manager’s choice, but shareholder rights are not significant.  In previous literature, 
legal origin has been shown to be related to market development.  Therefore, in addition to 
legal origin we introduce direct measures of capital market development.  Fund managers are 
found to allocate more funds to ADRs in countries that have small equity markets relative to 
the size of the economy, have lower market liquidity, and have higher transaction costs.  
Page  34
33
However, even after controlling for direct measures of market development, legal origin 
continues to be significant.   
At the firm-level, we find that mutual fund managers are more likely to invest in an 
ADR relative to the domestic stock if the liquidity of the domestic security is low. In 
particular, if the ADR liquidity is higher than the domestic security liquidity, fund holdings 
are more concentrated in the ADR rather than the (low liquidity) domestic security. These 
results are consistent with the ease of trading argument that is frequently offered by industry 
participants as the primary reason for investors to hold ADRs.  These results also provide 
support for theoretical models which predict that if a security trades in multiple exchanges, 
the trading in such a security would tend to aggregate in the exchange with lowest transaction 
costs.   
Our findings suggest that ADRs can be an effective mechanism for firms in emerging 
markets to access institutional investment. Even after controlling for firm-level factors, 
country-level transactions costs and legal origin continue to be significant.  To summarize, we 
find that ADRs are the preferred mode of holdings if the local market of the issuer has weak 
investor protection, low liquidity and high transaction costs, and if the firm is small and has 
limited analyst following.  Our results also suggest that ADR listings of local firms might not 
negatively impact local markets if the investment climate is good.  
Page  35
34
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Page  38
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Figure 1 
The Relation between Regulatory Requirements and Liquidity 
 
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Page  39
38
 
Figure 2
Frequency Distribution Firms and Number of Funds Holding ADR Security
38
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Page  40
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Figure 3
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Page  42
41
Table 2 
Listed ADR Holdings 
 
This table shows summary statistics of ADR issuers from emerging market countries.  The second column shows the 
total number of firms included in Worldscope; the third column shows the percentage of firms in Worldscope that 
issue ADRs; and the last column shows the percentage of total market value of firms included in Worldscope that 
issue ADRs. 
 
Country 
 
#
of Firms in 
Worldscope 
%
of  Firms that  
Issue ADRs 
%
Market Value of 
Firms that Issue ADRs 
Argentina 84 
14.29% 
51.79% 
Brazil 371 
7.55% 
59.67% 
Chile 174 
10.92% 
31.04% 
China 193 
7.25% 
42.51% 
Colombia 30 
3.33% 
5.41% 
Czech Republic 
35 
0.00% 
0.00% 
Egypt 13 
0.00% 
0.00% 
Hungary 40 
2.50% 
37.81% 
Indonesia 219 
0.91% 
14.91% 
India 272 
3.31% 
34.22% 
Israel 94 
9.57% 
14.54% 
Jordan 9 
0.00% 
0.00% 
Korea 206 
2.91% 
41.35% 
Malaysia 551 
0.00% 
0.00% 
Mexico 134 
20.15% 
45.09% 
Morocco 11 
0.00% 
0.00% 
Pakistan 50 
0.00% 
0.00% 
Peru 14 
7.14% 
18.29% 
Philippines 180 
0.56% 
11.02% 
Poland 73 
1.37% 
2.19% 
Russia 23 
8.70% 
4.38% 
South Africa 
529 
1.51% 
6.49% 
Sri Lanka 
16 
0.00% 
0.00% 
Slovakia 8 
0.00% 
0.00% 
Taiwan 422 
1.42% 
19.48% 
Thailand 252 
0.00% 
0.00% 
Turkey 133 
0.75% 
11.02% 
Venezuela 40 
5.00% 
33.19% 
Zimbabwe 8 
0.00% 
0.00% 
Page  43
42
Table 3 
Descriptive Statistics for Fund Holdings, by Fund Type 
 
Panel A shows summary statistics of the emerging market funds segregated by Morningstar classification.  These 
include Diversified Emerging Markets funds, Latin America funds, and Asia funds (Pacific/Asia excluding Japan). 
T
hese are the three categories of funds covered by Morningstar that invest primarily in emerging markets’ equity. 
Panel B shows summary statistics of und holdings by country. The mean fund characteristic information is obtained 
from the Morningstar February 2002 database.  The holdings of each fund are examined to establish if the security 
held is an ADR or not.  The information on the listed status of the ADR is confirmed from a variety of sources 
including the Bank of New York website, the Deutsche Bank website and individual company websites. 
 
Fund Type 
# Funds 
Funds Net 
Assets 
($M) 
%
ADR Holdings in 
firms with: 
%
Domestic Security Holdings in  
firms with 
Listed 
ADRs 
Unlisted 
ADRs 
Listed 
ADRs 
Unlisted 
ADRs 
Non-ADRs 
Panel A: By Fund Type 
All 
Funds 
111 
98.2  20.6%  4.8%  20.5% 28.8% 25.3% 
Diversified 
Emerging 
73 
123.1 18.9%  6.6%  19.2% 29.0% 26.3% 
Latin 
America 14 
63.1  43.2%  3.2%  17.9% 21.0% 14.6% 
Asia 
24 
42.7  12.5%  0.1%  26.1% 32.8% 28.5% 
 
Panel B:  By Country 
Argentina 
40 
2.60 41.0% 0.0% 17.9% 3.2% 38.0% 
Brazil 
87 
14.12 25.5% 12.7% 32.2% 13.4% 16.3% 
Chile 
67 
3.28 78.7% 0.2% 13.9% 0.0%  7.2% 
China 
81 
3.31 11.9% 0.0% 64.5% 7.7% 15.9% 
Colombia 8 
1.86 
22.2% 
15.1% 
0.0% 
0.2% 
62.5% 
Czech  
Republic 
41 2.10 
0.0% 
9.7% 
0.0% 
37.7% 
52.6% 
Egypt 
31 
2.45  0.0% 36.9% 0.0% 36.6% 26.5% 
Ghana 
3 
0.01 0.0% 0.0% 0.0% 0.0% 100.0% 
Hungary 
66 
2.68 11.4% 5.9%  8.6% 65.3% 8.8% 
Indonesia 
47 
4.78 15.1% 0.3% 36.5% 9.3% 38.9% 
India 
85 
7.88  13.4% 12.3% 21.3% 28.0% 25.1% 
Israel 
67 
4.30 26.5% 0.3%  6.7% 14.3% 52.1% 
Jordan 
1 
0.79 0.0% 0.0% 0.0% 0.0% 100.0% 
Korea 
96 
20.40 11.0%  0.1%  26.6% 37.7% 24.7% 
Malaysia 76 
5.69 
0.0% 
0.1% 
0.0% 
22.9% 
77.0% 
Mexico 
87 
18.95 44.9%  3.0%  18.0% 22.1% 12.0% 
Morocco 
4 
0.78 0.0% 8.6% 0.0% 0.0% 91.4% 
Pakistan 6 
5.39 
0.0% 
0.0% 
0.0% 
35.9% 
64.1% 
Peru 
35 
1.18 49.0% 2.9% 11.9% 0.5% 35.8% 
Philippines 
52 
4.26  17.2%  0.0%  11.0% 46.9% 24.9% 
Poland 57 
3.38 
0.0% 
5.3% 
0.0% 
78.0% 
16.7% 
Russia 
64 
5.18  8.8% 67.1% 2.8% 17.7% 3.7% 
South 
Africa 
67 
13.69  2.1% 
0.1%  29.5% 33.0% 35.3% 
Sri Lanka 
5 
0.21 
0.0% 
0.0% 
0.0% 
46.7% 
53.3% 
Slovakia 
2 
1.57  0.0% 11.4% 0.0% 88.6% 0.0% 
Taiwan 
93 
11.91 24.0%  0.8%  12.6% 33.2% 29.3% 
Thailand 87 
4.36 
0.0% 
0.0% 
0.0% 
48.1% 
51.9% 
Turkey 54 
4.89 
8.4% 
3.0% 
1.5% 
55.3% 
31.8% 
Venezuela 
4 
1.19  0.0% 15.9% 0.0% 74.0% 10.1% 
Page  44
43
 
Table 4 
Characteristics of Firms in Fund Portfolios 
 
This table provides summary statistics of key firm attributes for the firms that are held by the emerging market 
mutual funds.  The holdings of each fund are examined to establish whether or not the security held is an ADR.  The 
p
rimary source for this data is Worldscope. The measures of liquidity are constructed using weekly trading data 
from Datastream.  The information on the listed status of the ADR is confirmed from a variety of sources including 
the Bank of New York website, the Deutsche Bank website and individual company websites.  *, **, and *** show 
significance at 10%, 5%, and 1% respectively. 
 
Listed  
ADR issuers 
Unlisted 
ADR issuers 
Non-ADR 
issuers 
t-statistics  
(Wilcoxan Rank-sum test)
 
(A) 
(B) 
(C) 
(A) - (B) 
(B) - (C) 
(A) - 
(C) 
Number of Firms 
 
136 
 
251 
 
974 
 
Market Value ($ billion) 
 
4.23 
1.24 
 
1.33 
0.65 
 
0.58 
0.17 
 
3.09*** 
5.28*** 
 
4.96*** 
9.64*** 
 
3.92*** 
12.56**
*
Book Value of  Assets  
($ billion) 
 
6.03 
2.32 
 
3.75 
1.17 
 
2.15 
0.45 
 
1.80* 
3.94*** 
 
2.81* 
7.97*** 
 
3.35*** 
9.92*** 
 
Market to Book   
 
4.33 
1.38 
 
1.54 
1.14 
 
0.96 
0.80 
 
1.89* 
2.56** 
 
0.07 
4.01*** 
 
2.00** 
5.96*** 
 
EBITDA to Sales (%) 
 
18.4 
17.29 
 
22.1 
13.77 
 
11.0 
11.34 
 
-0.42 
-1.65* 
 
1.06 
2.63*** 
 
1.45 
3.94*** 
 
Debt to Asset Ratio (%) 
 
29.2 
28.81 
 
25.5 
25.15 
 
28.2 
24.98 
 
1.91** 
2.16** 
 
-1.62 
-0.62 
 
0.63 
1.81* 
Page  45
44
Table 5 
Relationship between ADR versus Domestic Fund Holdings and Country Attributes 
 
The dependent variable is defined as the average (across all funds investing in a particular issuer) of the difference in 
the fraction of investment in the ADR and the fraction of investment in the non-ADR (underlying domestic) 
s
ecurity. Panel A of this table shows results for OLS regressions with robust errors for all ADRs as well as for listed 
ADRs sub-sample. Panel B provides the Tobit regression results in which the dependent variable is constrained to 
lie between -1 and +1.  GDP per capita is from IMF-IFS statistics.  Legal origins and shareholder rights is from La 
Porta, et al (1998).  The information on the listed status of the ADR is confirmed from a variety of sources including 
the Bank of New York website, the Deutsche Bank website and individual company websites.  *, **, and *** show 
significance at 10%, 5%, and 1% respectively. 
 
Panel A: OLS Regression
 
Panel B: Tobit Regression 
 
All ADRs 
Listed ADRs 
All ADRs
 
Listed ADRs
 
Intercept 
 
-0.80 
(-9.91)*** 
-0.39 
(-2.79)*** 
-0.63 
(-3.77)*** 
0.17 
(0.68) 
-1.78 
(-6.53)*** 
-0.91 
(-2.53)*** 
-0.99 
(-3.10)*** 
0.14 
(0.34) 
GDP Per Capita 
 
0.00 
(0.32) 
-0.00 
(-2.13)** 
0.00 
(0.45) 
-0.00 
(-1.11) 
-0.00 
(-0.50) 
-0.00 
(-2.13)** 
0.00 
(0.22) 
-0.00 
(-0.83) 
Legal Origin: 
French 
 
0.53 
(6.88)*** 
-
0.71 
(5.16)*** 
-
1.27 
(5.59)*** 
-
1.10 
(4.40)*** 
-
Legal Origin: 
German 
 
-0.05 
(-0.38) 
-
0.27 
(1.15) 
-
0.08 
(0.19) 
-
0.71 
(1.56) 
-
Legal Origin: 
Transition 
 
0.19 
(1.57) 
-
0.87 
(2.69)*** 
-
0.57 
(1.67)* 
-
1.39 
(2.48)** 
-
Shareholder 
Rights 
 
-
0.03 
(0.25) 
-
-0.00 
(-0.10) 
-
0.03 
(0.37) 
-
0.00 
(0.03) 
R
2
0.12 0.01 0.16 0.01 0.05 0.01 0.05 0.00 
F-stat 
 
14.05 
2.66 
7.39 
0.61 
- - - - 
Log likelihood 
 
-
-
-
-
-417.81 -418.17 -176.71 -172.59 
Wald LR chi
2
-
-
-
-
41.48 5.20 20.34 0.71 
N
387 369 136 126 387 369 136 126 
Page  46
45
Table 6 
Relationship between ADR versus Domestic Fund Holdings and Country Attributes 
 
The dependent variable is defined as the average (across all funds investing in a particular issuer) of the difference in 
the fraction of investment in the ADR and the fraction of investment in the non-ADR (domestic) security. Panel A 
o
f
this table shows results for OLS regressions with robust errors for all ADRs and listed ADRs, while Panel B 
provides the Tobit regression results in which the dependent variable is constrained to lie between -1 and +1.  GDP 
per capita, Market Cap/GDP, and US$ Exchange Rates are from IMF-IFS statistics.  Turnover is from Datastream.  
Transaction Efficiency is from CALPERS.  Legal origins and shareholder rights is from La Porta, et al (1998).  The 
information on the listed status of the ADR is confirmed from a variety of sources including the Bank of New York 
website, the Deutsche Bank website and individual company websites. *, **, and *** show significance at 10%, 5%, 
and 1% respectively. 
 
Panel A: OLS Regression 
Panel B: Tobit Regressions 
All ADRs 
Listed  ADRs 
All ADRs 
Listed  ADRs 
Intercept 
 
-0.25 
(-3.12)*** 
0.04 
(0.16) 
0.177 
(1.02) 
0.39 
(0.75) 
-0.46 
(-2.02)*** 
0.32 
(0.58) 
0.10 
(0.34) 
0.49 
(0.54) 
GDP Per 
Capita 
 
0.00 
(0.96) 
0.00 
(1.62) 
0.00 
(0.44) 
-0.00 
(-0.23) 
0.00 
(0.26) 
0.00 
(1.52) 
0.00 
(0.49) 
-0.00 
(-0.49) 
Market 
Cap/GDP 
 
-0.003 
(-4.69)*** 
-0.00 
(-0.44) 
-0.00 
(-1.57) 
-0.00 
(-0.51) 
-0.01 
(-3.20)*** 
-0.01 
(-1.50) 
-0.00 
(-0.87) 
0.00 
(0.12)) 
Turnover 
Country 
 
-0.002 
(-5.82)*** 
-0.00 
(-0.08) 
-0.00 
(-2.74)*** 
-0.00 
(-0.77) 
-0.00 
(-4.31)*** 
0.00 
(0.04) 
-0.00 
(-2.08)** 
-0.00 
(-0.74) 
Transactions 
Efficiency 
 
-
-0.34 
(-5.30)*** 
-
-0.35 
(-4.26)*** 
-
-0.70 
(-4.61)*** 
 -0.52 
(-3.63)*** 
Settlement 
Efficiency 
 
-
-0.10 
(-1.65)* 
-
0.06 
(0.48) 
 -3.45 
(-2.06)** 
 0.13 
(0.59) 
Exch. Rate 
Volatility 
 
-
-0.00 
(-1.11) 
-
0.00 
(2.07)** 
-
-0.00 
(-0.84) 
 0.00 
(0.89) 
Legal Origin: 
French 
 
-
0.66 
(6.14)*** 
-
0.60 
(2.30)** 
-
1.44 
(4.52)*** 
 0.93 
(2.01)** 
Legal Origin: 
German 
 
-
-0.19 
(-0.94) 
-
0.58 
(1.05) 
-
-0.34 
(-0.51) 
 1.28 
(1.18) 
Legal Origin: 
Transition 
 
-
0.09 
(0.51) 
-
0.78 
(1.91)* 
-
-0.01 
(-0.03) 
 1.33 
(1.95)* 
R
2
0.09 0.22 0.06 0.26 0.04 0.09 0.01 0.10 
F-stat 
 
16.00 15.44  3.06  32.02 
- 
- 
- 
- 
Log likelihood 
 
-
-
-
-
-422.59 -399.10 -184.51 -168.84 
Wald LR chi
2
-
-
-
-
31.90 74.67  4.75  36.09 
N
387 385 136 136 387 385 136 136 
Page  47
46
Table 7 
Relationship between ADR versus Domestic Fund Holdings and Firm & Country Attributes 
 
The dependent variable is defined as the average (across all funds investing in a particular issuer) of the difference in 
the fraction of investment in the ADR and the fraction of investment in the non-ADR (domestic) security. Panel A 
of this table shows results for OLS regressions with robust errors for all ADRs and listed ADRs, while Panel B 
provides the Tobit regression results in which the dependent variable is constrained to lie between -1 and +1.  
Market Cap is from Worldscope.  Number of Analysts is from by I/B/E/S.  Liquidity is from Datastream.  GDP per 
capita, Market Cap/GDP, and US$ Exchange Rates are from IMF-IFS statistics. Transaction Costs is from 
CALPERS.  Legal origins and shareholder rights is from La Porta, et al (1998).  The information on the listed status 
of the ADR is confirmed from a variety of sources including the Bank of New York website and individual company 
websites.  *, **, and *** show significance at 10%, 5%, and 1% respectively. 
 
Panel A: OLS Regressions 
Panel B Tobit Regressions 
All ADRs 
Listed ADRs 
All ADRs 
Listed ADRs 
Intercept 
 
-0.95 
(-2.50)** 
-1.13 
(-2.56)** 
0.79 
(1.05) 
0.76 
(0.71) 
-3.36 
(-3.34)*** 
-3.56 
(-3.34)*** 
1.03 
(0.80) 
1.13 
(0.71) 
Log Market Cap. 
 
0.04 
(1.57) 
0.08 
(2.88)*** 
-0.06 
(-1.10) 
-0.00 
(-0.00) 
0.20 
(2.76)*** 
0.28 
(4.15)*** 
-0.08 
(-0.92) 
-0.00 
(-0.01) 
Number of Analysts 
 
-0.01 
(-1.78)* 
-0.01 
(-1.57) 
-0.00 
(-0.15) 
0.01 
(0.81) 
-0.02 
(-1.30) 
-0.02 
(-1.20) 
0.00 
(0.02) 
0.02 
(1.11) 
Liquidity 
–Underlying 
 
-14.14 
(-4.95)*** 
-1.72 
(-0.52) 
-
-
-67.41 
(-3.16)*** 
-18.73 
(-0.98) 
-
-
Liquidity- Relative 
 
-
-
0.03 
(2.82)*** 
0.04 
(3.99)*** 
-
-
0.04 
(2.62) *** 
0.08 
(3.39) *** 
Accounting Quality 
 
-0.04 
(-0.86) 
-0.00 
(-0.07) 
-0.05 
(-0.66) 
-0.13 
(-1.41) 
-0.16 
(-1.40) 
-0.05 
(-0.40) 
-0.06 
(-0.45) 
-0.21 
(-1.52) 
GDP Per Capita 
 
-
0.00 
(0.44) 
-
-0.00 
(-0.06) 
-
0.00 
(0.32) 
-
-0.00 
(-0.07) 
Market Cap/GDP 
 
-
0.00 
(0.34) 
-
-0.00 
(-0.09) 
-
-0.00 
(-0.39) 
-
0.00 
(0.13) 
Turnover Country 
 
-
0.00 
(0.47) 
-
-0.00 
(-1.05) 
-
0.00 
(0.41) 
-
-0.01 
(-0.98) 
Transaction 
Efficiency 
 
-
-0.35 
(-4.73)*** 
-
-0.42 
(-4.12)*** 
-
-0.71 
(-4.26)*** 
-
-0.65 
(-3.84) *** 
Settlement Efficiency 
 
-
-0.08 
(-0.96) 
-
0.13 
(0.83) 
-
-0.25 
(-1.32) 
-
0.19 
(0.78) 
FX Volatility 
 
-
-0.00 
(-0.74) 
-
-0.00 
(-1.65) 
-
-0.00 
(-0.56) 
-
-0.00 
(-1.83)* 
Legal Origin: French 
 
-
0.73 
(5.00)*** 
-
0.28 
(0.61) 
-
1.63 
(3.88)*** 
-
0.37 
(0.50) 
Legal Origin: German 
 
-
-0.15 
(-0.40) 
-
0.58 
(0.68) 
-
-0.22 
(-0.23) 
-
1.07 
(0.72) 
Legal Origin: 
Transition 
-
0.29 
(1.00) 
-
0.61 
(0.84) 
-
0.49 
(0.73) 
-
0.88 
(0.84) 
R
2
0.05 
0.26 
0.08 
0.35 0.04 0.12 0.03 
0.15 
F-stat 
8.48 9.76 2.65 
23.86 
- - - 
- 
Log likelihood 
-
-
-
-
-332.05 -303.91 -157.60 
-137.47 
Wald LR chi
2
-
-
-
-
27.95 84.23  8.28 
48.54 
N
318 318 118 
118 
318 
318 
118 
118 
Page  48
47
 
Appendix A 
Description of Major Variables 
 
Panel A: Dependent Variables 
(ADR_Differential)
i
For each firm 
i
,
we first identify all funds that hold an investment in that firm. This 
investment can be either in ADRs, in the underlying domestic security or in both.  For 
i
llustration let us assume that there are 
k
funds that have hold an investment in firm 
i.
 To 
estimate the relative weighting of investments in ADR versus the domestic security for 
this firm we follow a two step process. In the first step, for each fund 
k
we calculate the 
total dollar amount of investment in firm 
i, 
that a fund holds. We then calculate the 
fraction of that investment in the ADR and the fraction in the underlying for that fund. 
Next, we take the difference between the fractions of investment in the ADR versus the 
underlying stock; this difference reflects the relative over or underweighting in ADR for 
that fund.  We repeat this process for all the 
k
funds, thus generating the relative over or 
under allocation of investment in ADRs for each fund. In the second step, we take a 
simple average of these 
k
values to get the aggregate measure of over/underweighting 
across all funds that invest in the firm 
i
and denote it  by (
ADR Differential)
i
.
(Source: 
Morningstar) 
(ADR_Ratio)
i
For a particular issuer 
i
,
the 
ADR_RATIO
 is also calculated in two steps. First, the total 
value (U.S. dollar amount) of investment by all funds in that firm is calculated.  This 
calculation includes all securities issued by issuer 
i
(for most issuers it is the ADR and 
the domestic security of that issuer).  The second step involves calculating the total 
investment by all funds in the ADR security of firm 
i.
 
ADR_RATIO
 is calculated by 
taking the ratio of investment in ADR security of firm 
i
by all funds to the investment in 
all securities of firm 
i
by all funds. (Source: Morningstar) 
Panel B: Independent Variables 
Country-Level Variables 
English 
Dummy equals 1 if the country has English legal origins (Source: LLSV 1997) 
French 
Dummy equals 1 if the country has French legal origins (Source: LLSV 1997) 
German 
Dummy equals 1 if the country has German legal origins (Source: LLSV 1997) 
Transition 
Dummy equals 1 if the country is a former Soviet Union Block (Source: Authors) 
Shareholder Rights 
An index constructed to capture the rights of minority shareholders and is the sum of 
dummies identifying one-share/one vote, proxy by mail, unblocked shares, cumulative 
vote/proportional representation, preemptive rights, oppressed minority, and percent of 
shares needed to call a shareholders’ meeting. (Source LLSV 1997, Pistor 2000) 
Market Cap/GDP 
Total Stock market capitalization in US $  divided by GDP (Source: IMF/IFS Statistics) 
Turnover Country  
Turnover of market index in 2000.  (Source: Datastream) 
Transaction Efficiency 
and 
Settlement Efficiency 
A
categorical variable that ranges from one to three; higher score means lower 
transaction/settlement costs and therefore higher efficiency. (Source: Wilshire 
Consulting Group’s report for California Public Employees' Retirement System).   
GDP per Capita 
Source: IMF/IFS Statistics 
FX Volatility 
Standard deviation of  weekly exchange rates from July 2000 to July 2001  (Source: 
IMF/IFS Statistics) 
Firm-Level Variables 
Domestic Liquidity 
Ratio of average daily volume of the underlying divided by average number underlying 
outstanding in 2000. (Source: Datastream) 
Relative Liquidity 
Ratio of average volume of ADR (converted into equivalent number of underlying) to 
average daily volume of underlying in 2000 (Source: Bloomberg) 
ADR fraction 
Fraction of underlying security in the form of ADR at the end of 2000 (Source: 20-F 
filings for year 2000, Bank of New York) 
Log Market Cap 
Natural Log of market cap of the firm in US $ at the end of 2000 (Source: Worldscope) 
Number of Analysts 
Source IBES 
Accounting Quality 
We create an index of firm-level accounting quality (
Accounting Quality) 
which equals 
the sum of the four separate accounting quality variables: Use of an international big-5 
accounting firm, consolidation of financial reports, receipt of a clean audit opinion, and 
reconciliation with either U.S. GAAP or International Accounting Standards. (Source: 
WorldScope) 
Page  49
48
 
Appendix B 
Country-level Characteristics 
GDP per capita and Market capitalization to GDP are from World Development Indicators 2004 database.  Market 
turnover is from Datastream; Legal origins and shareholder (SH) rights is from La Porta, et al (1998).  Foreign 
Exchange (FX) volatility is the standard deviation of  weekly exchange rates and is from IMF/IFS Statistics. 
Settlement Proficiency and Transaction Efficiency are from CALPERS’ Permissible Equity Market Analysis and 
can have a score between one and three with three implying the highest relative standards 
 
Country GDP 
per 
Capita 
Legal 
Origin 
SH  
Rights 
Market 
Cap/ GDP 
Market 
Turnover 
FX 
Volatility 
Settlement 
Proficiency 
Transactions 
Efficiency 
Argentina 12058.8 French  4 
58.40 
4.77  0.0002 
2 
3 
Brazil 7446.0 
French 
3 
37.58 
43.48 
0.1860 
2 
3 
Chile 9097.0 
French 
5 
79.99 
9.36 
22.1148 
2 
1 
China 3837.1 
None 
. 
53.77 
158.29 
0.0010 
3 
2 
Colombia 6004.9 French 3  11.49  3.85 68.5079 
1 
2 
Czech Rep. 
13867.6 
Transition 
3 
21.39 
60.26 
1.3183 
1 
2 
Egypt 3518.5 
French 
2 
28.91 
34.74 
0.1586 
2 
2 
Ghana 1933.1 
English 
. 
10.09 
1.48 . 
. 
. 
Hungary 12228.0 
Transition 
3  25.75 90.65 
10.5403  1 
3 
India 2388.3 
English 
5 
32.14 
133.64 
0.6747 
1 
2 
Indonesia 3036.0 
French 2  16.29 32.92 
981.5374  2 
2 
Israel 20055.1 
English 
3 
58.05 
36.29 
0.0474 
3 
2 
Jordan 3892.2 
French 
1 
58.39 
7.72 
0.0006 2 
3 
Korea 15074.5 
German 
2 
37.18 
233.19 
82.1983 
3 
2 
Malaysia 8884.3 
English 4 129.87 
44.59 
0.0000 
2 
3 
Mexico 8837.0 
French 
1 21.56 
32.28 
0.2312 3 
3 
Morocco 3455.7 
French .  32.71 9.22 0.4085 
1 
2 
Pakistan 1893.0 
English 
5 10.83 
475.46 
3.2383  2 
2 
Peru 4729.7 
French 
3 
19.75 
12.60 
0.0357 
2 
3 
Philippines 3853.4 French 
3 
68.87 
15.84  2.5155 
1 
2 
Poland 9843.6 
Transition 
3 
19.09 
49.93 
0.2294 2 
2 
Russia 7260.4 
Transition 
4 
14.99 
36.90 
0.5108 1 
2 
Slovakia 11344.5 
Transition 
2.5 3.76 129.75 
. 
. 
. 
South Africa 
9579.5 
English 
5 
160.16 
33.90 
0.4199 
1 
3 
Sri Lanka 
3441.6 
English 
3 
6.59 
10.96 
4.5957 
1 
2 
Taiwan 17400.0 
German 
3 80.03 
305.59 
0.9886  3 
2 
Thailand 6315.8 
English 2 24.38 53.20 
1.7674 
3 
1 
Turkey 6189.0 
French 
2 
34.96 
206.19 
233558.94 
3 
3 
Venezuela 5595.2 French  1 
6.70 
8.90 10.1921 
1 
2 
Zimbabwe 2569.6 English  . 
33.76  10.77 5.3450 
. 
. 
Page  50
49
Appendix C 
Correlation across different firm-level Variables 
 
Country 
Log Market 
Cap. 
 
Number  of 
Analysts 
 
Liquidity 
Firm 
 
Acct. 
Quality
 
Log Market Cap. 
 
1.0000 
 
Number  of Analysts 
0.3372 1.0000 
 
 
Liquidity Firm 
 
-0.0707 0.1389 1.0000 
 
Acct. Quality 
 
0.0104 0.2136 0.0155 1.0000