Investigating the Investment Environment
While shares in foreign firms known as American depositary receipts (ADRs) can help diversify investors’ portfolios and fetch high returns, they also pose risk in countries where protections for investors are limited and firms’ information environments – the quality, quantity and timing of earnings releases – are unpredictable or opaque.
Finance researchers Zhipeng (Alan) Yan and Xinyuan (Stacie) Tao are examining how the stock-price activity of ADRs, which are traded in the U.S. financial market and denominated in U.S. dollars, reflect these uncertainties.
Using Thomson-Reuters’ financial database, they developed a sample size of 44 developed and underdeveloped countries, and reviewed and summarized for each one the number of earnings announcements at a given number of firms over 22 years — focusing on the timing of release of these announcements to assess levels of information leakage, as measured by ADR stock-price volatility. They also aggregated World Bank data on governance indicators, including regulatory quality and rule of law.
One early finding: When earnings announcements are managed well, greater volatility occurs just around the announcement window. This signifies good governance, because it indicates information has not been leaked during the normal period. Among poorly governed countries, however, there is less difference between volatility within the event window and the normal period and even improvement in country governance does not benefit the information environment.
Data at the firm level paints another story. In well-governed countries, differences across firms do not matter much to ADR investors, because the overall information environment is good. “But for a country with poor management, it’s the opposite,” Tao, assistant professor of finance at Martin Tuchman School of Management (MTSM), said. “The level of information leakage can vary greatly across firms, so investors need to do their research. Firm factors are more important than the country itself.”
She and Yan are mining more evidence to support their analysis, with plans to also explore how U.S. investors can best trade ADRs.
“These securities are a convenient way for U.S. investors to invest overseas,” said Yan, MTSM associate professor of finance. “If you focus on U.S. stocks, you give up the much bigger pie of the global economy.”
