How is the price of an American Depository Receipt (ADR) determined?
An American Depository Receipt is a receipt that a non-U.S. share is held by a bank on behalf of the receipt holder. If you hold an ADR, you often have to pay an annual fee, but holding the underlying share does not incur this fee. This makes the underlying shares a little "better" than the ADRs. Because of the law of one price, this disadvantage of ADRs must be compensated by setting the ADR price a little lower than the price of the underlying shares. Otherwise, it would be profitable to take a short position in the ADR and a long position in the underlying share, and large institutional investors would take advantage of this.
If you take a long position in the underlying share and a short position in the ADR, you aren't taking any position in the company, but only in the ADR fee.
How much lower must the price of the ADR be? Does this affect ADR volumes? If the price drops too much below the value of the underlying shares, it becomes profitable for large institutional investors to buy ADRs, cancel them and sell the underlying shares.