Bad Watchdog Season 2 launches June 20.

Championing Responsible National Security Policy

Testimony of POGO's Danielle Brian Before the Senate Armed Services Subcommittee on Acquisition and Technology

I appreciate the opportunity to testify on this important subject. I am the Executive Director of the Project On Government Oversight -- a non-profit, non-partisan government watchdog group, that for over sixteen years, has exposed and worked to eliminate abuse of power, mismanagement, and acquiescence to corporate interests by the federal government. For the first nine years, our organization dealt exclusively with defense issues as the Project on Military Procurement.

We have always been supporters of a strong national defense. We also believe in a reasonable consolidation of the defense industry that takes great care in assisting displaced workers, and maintains an adequate level of competition in each sector.

However, we believe that the new DOD practice of reimbursing defense contractors' merger-related restructuring costs is a clear example of the Pentagon's acquiescence to the defense industry's interests -- and is counter to the interests of the American public.

This debate over subsidizing restructuring costs has taken on an Alice-in-Wonderland-like quality. I will address four main points:

  • First, we hear of "savings" yet the GAO and DOD have not been able to uncover any actual lower prices for the Pentagon.
  • Second, we see merger-mania across the economy, but hear of defense contractors who claim they are reluctant to acquire their competitors until the government pays them to do so.
  • Third, we discover the Pentagon's new "economics" that reducing competition will now lead to greater efficiency and lower prices.
  • Fourth, and finally we were told that this subsidy policy was in large part to assist the tens of thousands of workers who will lose their jobs, but now discover only 10% was available for the displaced workers, while at the same time CEOs have received multi-million dollar bonuses.

To expand on my first point, contrary to commonly-held belief, there have been NO proven examples of the DOD getting weapons at reduced prices as a result of mergers. Every statistic we have heard today is only an industry estimate or projection. In fact, neither contractors nor Pentagon auditors have even set up accounting procedures to begin to identify these promised savings.

Originally, in Congressional testimony, the Pentagon projected savings of between one and a half and seven times the government subsidy. Now industry is reduced to quoting the DCAA estimates of $1.93 saved for every government dollar spent -- however these are not government estimates at all, but estimates based on industry's own projections -- hardly bottom-line savings for the public.

Let me make it clear that neither the GAO nor the DOD have found one scintilla of hard evidence that there will be any savings for the government as a result of a merger. In fact, the GAO emphasized that its recent estimates do not even include the additional government expense of nearly $48 million in Department of Labor and additional DOD grants to assist the displaced workers from just the five business combinations they reviewed.

The conference language for Section 818 of the FY95 Defense Authorization Act concluded, "DOD policy should ensure that contracting officers make every reasonable effort to price the projected savings into current contracts, thereby increasing the likelihood that actual savings will be obtained for the taxpayers rather than relying only on projections." (emphasis added) This has not happened. Despite these warnings, we are relying entirely on industry's projections.

During the original hearings held by Representative Norman Sisisky in 1994, then-Deputy Secretary of Defense John Deutch suggested it was still too early to show savings. Now, three years later, apparently it is still too early. Will we ever see actual reductions in weapons costs as directed by Congress?

My second point is, defense industry management and their Boards of Directors do not need to have their expenses covered by the government before they decide to merge or to acquire their competitors. They will obviously make that decision when it is most advantageous for the financial success of their companies.

The notion that these government subsidies will have a substantial impact on the decision to merge or on the timing of a merger is simply ludicrous. The use of tax dollars to increase these companies' already healthy corporate profits is outrageous.

Why are non-defense companies, who do not receive this subsidy, flocking to beg the Justice Department and Federal Trade Commission for permission to merge? According to a recent Fortune magazine, in 1996 alone, merger activity reached $660 billion.

Why were defense contractors themselves already merging before they received the subsidy? The industry will naturally consolidate in order to maximize profits. The taxpayer does not and should not need to assist the process.

Third, our economy is based on the principles that free-market competition is good, and that government interference should be limited. Why, then should we now endorse a practice that contradicts these principles? What we are talking about is a practice that tries to encourage more mergers than would naturally occur in the marketplace. This will reduce competition further, thereby raising prices in the long-run. Pentagon acquisition chief Dr. Paul Kaminski himself has noted that due to the competition between Raytheon and Hughes the price of the AMRAAM Missile was cut by 70%.

Mergers will squeeze out small businesses, as they will only have one or two giant monopolistic primes left to whom to sell their parts. The government itself will have only one or two giants from whom to buy weapons, thus reducing our ability to turn elsewhere when a company does not perform adequately.

This can hardly be consistent with the economic principles of any of the Members of this Committee, and it certainly should not be paid for by the American public.

The fourth and final point, when justifying the 1993 shift in practice, Mr. Deutch testified:

"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."

This sounds great. It certainly does paint a sympathetic picture of the purpose behind this subsidy. But what has the GAO found? Despite the earlier appealing rhetoric, they found that only about 10% of the money received from this subsidy was spent to assist the workers who lost their jobs because of these mergers.

At the same time, since the mergers, executive compensation has skyrocketed. For example, Norman Augustine, CEO of Lockheed-Martin, the most visible proponent of this new practice, billed the government for an $8 million personal bonus for this merger. Loral CEO Bernie Schwartz, who incidentally sat on the Defense Science Board's panel that established the Pentagon's pro-merger stance, personally received $18 million when Loral was bought by Lockheed.

Now, I am sure that industry representatives will argue that our subsidies to their clients have not gone directly to executive compensation -- but it certainly does look as though we have made it a lot easier with these subsidies for these companies to syphon off millions of dollars to line the pockets of their executives.

I don't believe this change in practice would have been accepted by the Congress in 1993 if you knew about the exorbitant CEO bonuses that were yet to come.

History has certainly shown us that we are facing a "camel's nose under the tent" phenomenon, where once public scrutiny has waned, it will require an army of government auditors to keep these costs in check. Adding layers of auditors to regulate this new practice is a step backwards.

Finally, I believe the solution is quite simple. The Senate should pass the language unanimously passed by the House last year prohibiting the reimbursement of restructuring costs.

I strongly believe that the policy of reimbursing contractor's restructuring costs has nothing to do with maintaining a robust industrial base. It is simply an unjustifiable perk, at a time of scarce budget resources. Industry representatives have been very good at blurring the distinction between what is in their client's interests and what is in the public interest. Ultimately, what is needed is for us to recognize this distinction and make a policy that is based on fact, not optimistic projections. We should not pay for their restructuring costs.