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Project on Government Oversight
 

 

 

 

An Assessment of the Defense Department's Merger Payments Report

July 2, 1996 

 

In June 1996 the Defense Department released its Report on Payment of Restructuring Costs under Defense Contracts. The report, mandated by law, was more than half a year overdue.

Congress established the report requirement in an effort to protect the public treasury from abuses of a controversial new policy. The policy directs the Pentagon to pay private corporations for "restructuring" or downsizing costs following a merger. The policy has been criticized for subsidizing anti-competitive mergers and promoting large-scale layoffs while paying executives exorbitant salaries. The legislation attempted to get the Defense Department to provide data supporting its policy and to certify that paying corporations for mergers would result in savings to the government.

  • The report is very optimistic about savings, but in fact provides only a qualified certification of future savings: the Under Secretary of Defense for Acquisition and Technology "certifies that projections of future cost savings resulting for the Department are based on audited cost data and should result in overall reduced costs for the Department." [pp.1-2, emphasis added] The assessment is based on projected savings and "estimated actual restructuring savings." [p.10] The problem is that it is not possible to attribute particular price changes to a merger, given the many other factors that influence the setting of prices.

  • In the few case studies provided, Defense Department costs were "projected" to be $256 million, and savings $1.146 billion. In response to the legislation's requirement to provide the "actual experience" with savings, the Defense Department admits that it can't provide the figures and demonstrate actual savings, for methodological reasons:

"Savings" are not recorded within a contractor's book of accounts and are not readily available. Savings could be estimated by comparing cost projections before restructuring with actual costs after restructuring, or by comparing actual costs after restructuring with estimated costs that would have been incurred had there been no restructuring. However, restructuring is not the only determinant of actual costs. Other factors such as inflation, business fluctuations, accounting system changes, subsequent reorganizations, and unexpected events also impact actual costs. It is not 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. [p.10, emphasis added]

So the Department bases its savings estimates on methods such as the future application of "the difference in rates used to price new contracts before and after the business combination"; "a pricing model which compares company headcounts"; and on "a comparison of costs before and after the restructure" [p.11].

  • Even if the Department could show confidently that it will realize short-term savings, the report makes far too narrow an assessment of "costs" to provide a rationale supporting the new policy. It does not take into consideration the longer-term costs of subsidizing mergers, most notably a further reduction of competition in the defense industry. Recently-merged Lockheed Martin Loral alone will control an astounding 40% of the defense procurement budget. Lockheed Martin announced the layoff of 19,000 workers soon after its merger, yet submitted a $31 million executive compensation bill for former Martin Marietta executives.

  • A broader, government-wide, longer-term assessment is needed to help determine whether the full costs of this policy over time produce a net gain or loss for the government.

  • The report did not include information on the huge merger of Lockheed, Martin Marietta, and later Loral, whose CEOs suggested the new reimbursement policy in the first place. Lockheed Martin has already requested taxpayer reimbursement for $855 million in restructuring costs, with requests for hundreds of millions of dollars more expected.

  • In lobbying for the new policy, CEOs claimed the subsidies were needed to convince them to undertake mergers that would otherwise be economically unsound. The report does not provide information on whether the corporations claim they would not have undertaken these particular mergers in the absence of government support. Although the government should not be intervening to promote mergers in the first place, if the CEOs wish to pursue their line of argument that subsidies as inducement, more information should be gathered from corporations for future reports to back up their claims.

  • Although the report provided little detail on the types of costs charged to the government, severance benefits for laid-off workers amounted to only 9% of the total bill for the three mergers. The policy is clearly not geared toward easing the transition of laid-off workers.

In sum, the report meets the limited requirements of the legislation, but provides little support for the policy since it does not and cannot prove savings, does not provide information on the broader costs and longer-term implications of the policy, and certainly does not address the purported need of the government to promote mergers in the first place.
 


Founded in 1981, the Project On Government Oversight (POGO) is a nonpartisan independent watchdog that champions good government reforms. POGO's investigations into corruption, misconduct, and conflicts of interest achieve a more effective, accountable, open, and ethical federal government.

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