How is Earnings News Transmitted to Stock Prices?

We examine the speed and mechanism of the price discovery process following earnings announcements in the after-hours market, a very illiquid trading environment. Prices reflect earnings surprises mostly through changes in quotes rather than through trades. Following positive announcement surprises, ask prices adjust quickly while bid prices are slower to adjust, and vice versa for negative surprises. Returns computed from trade prices underestimate the speed and magnitude of price reactions following announcements relative to returns computed from quotes. These findings emphasize the importance of using quotes and not trade prices when examining intraday price discovery. Because firm announcements such as earnings generally occur in the after-hours market, using quotes is crucial as trading is sparse. We further illustrate the importance of quotes when examining the price discovery process around analyst recommendation revisions.