Foreign Ownership Restrictions, Depositary Receipt Supply, and Investor Sentiment on Taiwanese Depositary Receipt Premiums

This paper focuses on the price difference between depositary receipts (DRs) and the underlying securities issued by Taiwanese firms under foreign ownership restrictions. We examine two issues: (1) the price relationships between DRs and their underlying securities, and (2) the determinants of the price differences between DRs and their underlying securities. The empirical results show that large daily price differences are observed between DRs and their underlying Taiwanese securities. However, these price differences do not exist for DRs traded in different free-entry countries. We examine the determinants of the price differences between DRs and their underlying securities, and find that the time-series qualified foreign institutional investor (QFII) surplus, defined as the QFII ownership limit ratio minus the actual QFII ownership ratio, is inversely associated with the DR premium. As the foreign ownership restrictions become tighter, the QFII surplus decreases and the DR premium increases. The results also indicate that a structural change in the relationships between DR premiums and investor sentiment variables occurred in 1997. The DR premiums are sensitive to non-QFII holdings, defined as the total foreign holdings minus the QFII holdings, before 1997. However, post 1997 the DR premiums become more sensitive to firm size, but less sensitive to non-QFII holdings post 1997. The change in demand caused by regulation and investor sentiment is reflected in DR prices, which leads to the variations in DR premiums. Furthermore, this study finds a supply-side effect on DR premiums. As firms increase DRs issues, the DR premiums become smaller. This study concludes that regulation, investor sentiment (both can be viewed as demand for DRs), and supply conditions explain the DR premiums.