This paper examines how auditors assign fees to dividend initiations conditional upon the investment opportunities available to the firm. We examine whether auditors perceive a positive signal arising either from managerial confidence in sustainable future cash flow or from a reduction of risk associated with agency problems due to over-investment. Our results show that a dividend initiation appears to moderate the perceived risk of asset misappropriation, in the sense that initiators with a greater propensity to over-invest exhibit lower audit fees than nonpayers. Further, auditors appear to price the risk of dividend-paying firms, which already mitigate over-investment and discretionary cash flow hazards, higher than for firms that initiate dividends, suggesting that the fee reduction for initiators is also related to the signal of their sustainable cash flows and commitment to reduce discretionary use of liquid funds. We find additional evidence for signaling in that under-invested initiators are assessed lower fees. Both signaling and agency theory support auditors’ lower perceived risks of dividend initiating firms, but the strongest evidence of perceived lower audit risk is in firms with the potential for agency problems
