SEC Follow Up Exhibits Part C SEC_OEA_FCIC_001760-2501

Panels B, C and D examine the effect of the level of short sales over a longer time horizon.
The level of short selling, whether on the offer day or cumulatively over the first month of
trading, has no relation to returns over a one month or three month time period. 38
Finally, in Panel D, we examine whether short selling is profitable only for the sample of
IPOs that have rebate rate data. After the cost of borrowing is taken into account and controlling
for only IPOs that have lending activity in our data, the level of short selling, on the first trading
day is still unrelated to subsequent returns. 39 Thus, we conclude that short sellers are unlikely
candidates to substantially mitigate any overvaluation.
7. Potential Effects of Market Maker Activity
A natural question arises as to whether the results, thus far, are due to market making activity
rather than the short selling of others. A number of papers have shown the importance of market
making activity in the aftermarket trading of IPOs, particularly on the Nasdaq (Krigman, Shaw
and Womack (1999), Ellis, Michaely and O’Hara (2000) and Ellis (2006)). Further, market
makers are expected to short when prices are rising and can do so even when other short sellers
are constrained as they are exempt from the locate requirement in Reg SHO and some execution
rules on short sales. Although the short selling transaction data does not indicate the identity of
the trader or whether or not the short sale was done by a market maker, the data does contain an
indicator if the short sale is “exempt”.
38
The three month return and profitability are significantly and negatively related to the level of short selling on the
first trading day if clustering is not used.
39
A preliminary test of whether a long/short portfolio of shorting IPOs with high short selling and going long IPOs
with low short selling using quintiles in each offer month generates zero three month abnormal returns (Diether, Lee
and Werner (2007a)). Given the small sample size and short time series this test is admittedly crude but is consistent
with the low level of profitability documented by our other tests.
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