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Government Payments for Defense Industry Mergers - Talking Points

June 25, 1996 

 

Following a June 1993 request by the CEOs of Martin Marietta, Hughes, Lockheed, and Loral, Under Secretary of Defense John Deutch permitted corporations, for the first time, to bill the government for "restructuring" costs incurred after a merger or acquisition. Mergers involving several of these corporations soon followed.

Under highly favorable "flexibly priced" contracts, which make up almost half of all Defense Department contracts,1 corporations are allowed to bill the government when their costs rise, or in this case, they incur merger costs.

  • Under the revised policy the merged Lockheed Martin Corporation has already submitted bills for $855 million in restructuring costs.2 Further requests for hundreds of millions of dollars from Lockheed Martin alone are expected, and other corporations could add "several billions of dollars" to government outlays, according to the General Accounting Office.3
  • The policy contributes to the problem of extravagant corporate executive salaries since corporations have been permitted to bill executive compensation as restructuring costs. In the most controversial case, after its merger Lockheed Martin requested $31 million from the taxpayer for former Martin Marietta executives.4
  • At the same time as the policy uses government funds to pay lavish executive salaries, it also subsidizes huge layoffs of workers in post-merger downsizing. Lockheed Martin announced the layoff of 19,000 employees soon after its merger.5 Then-Deputy Secretary Deutch put a benign face on the policy for Congress by noting that "restructuring costs include such things as relocation, retraining, and severance for workers. Allowable restructuring costs do not include such things as golden parachutes for executives and fees for investment bankers." According to labor unions, however, little money has gone to workers.6
  • According to CEOs themselves, the policy leads the government to intervene in the free market, promoting corporate mergers even when the market rules against them. Martin Marietta Chairman Norman Augustine testified that his company would not have acquired General Dynamics Space Division without government payment of restructuring costs and sharing of savings because it would have been "a bad business deal."7 Savings for the government from corporate mergers are unlikely to materialize when government bureaucrats, rather than private corporations, are deciding which mergers are more efficient than others.
  • However, the claim that corporations need government subsidies to convince them to merge is itself highly implausible. The wave of major defense mergers and acquisitions in the 1990s belies the claim, and shows that business leaders privately understand the many sound economic reasons to undertake mergers, that hold true even when the corporations pay their own costs and pass on direct savings to the government. Not least, more efficient contractors can make more profit on their "fixed price" contracts with the government, improve their profits on all their commercial business, bid lower on future government contracts, and expand their market share. Merger subsidies are not needed to promote mergers, and hence are not needed for the government to realize savings accruing from mergers.
  • Further, many are skeptical that promised savings to the government - which is the ostensible rationale for the government paying costs up front - will materialize at all. Creation of subsidized mega-corporations - Lockheed Martin Loral alone now accounts for 40% of defense procurement spending8 - will likely stifle competition in the defense industry. And savings are hard to prove. As the Department of Defense admitted,

    "Savings" are not recorded within a contractor's book of accounts and are not readily available. ... restructuring is not the only determinant of actual costs. Other factors such as inflation, business fluctuations, accounting system changes, subsequent reorganizations, and unexpected events are also determinative. It would not be feasible to completely isolate the effect of restructuring from other complex determinants of the difference between projected and actual costs over a long period of time.9

Paying corporations up front for promised future savings is an invitation for abuse of the public treasury, given the abysmal track record of many defense contractors in actually producing promised cost savings.



Endnotes

1. "Defense Industry Restructuring: Achieving Savings for DoD," Statement of John M. Deutch, Deputy Secretary of Defense before the Committee on Armed Services, House of Representatives, July 27, 1994, p.3.

2. Letter from Louis G. Becker, Defense Contract Management Command, to Rep. Bernard Sanders , June 7, 1996.

3. Defense Industry Consolidation: Issues Related to Acquisition and Merger Restructuring Costs, David E. Cooper, T-NSIAD-94-247, General Accounting Office, July 27, 1994.

4. Advance Agreement Regarding the Costs Allowability of Benefits Due to the "Change of Control" as Defined in the Various Plans#, Exhibit B, "Martin Marietta Heritage Change of Control Breakdown," May 5, 1995.

5. "Lockheed Martin Will Pare 19,000 Workers," John Mintz, Washington Post, June 27th, 1996.

6. Letter from George J. Kourpias, International President, International Association of Machinists and Aerospace Workers to Rep. Bernard Sanders, May 15, 1996.

7. Testimony of Norman R. Augustine, Chairman and Chief Executive Officer, and A. Thomas Young, President and Chief Operating Officer, of Martin Marietta Corporation to Oversight and Investigations Subcommittee, House Armed Service Committee, Washington, D.C., July 27, 1994, p.5.

8. "Merger Mania," Lawrence J. Korb, Brookings Review, Summer 1996, p.22.

9. Defense Restructuring Costs: Payment Regulations Are Inconsistent With Legislation, NSIAD-95-106, General Accounting Office, August 1995, Appendix I, "Department of Defense Comments."

 


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