Stock buybacks in defense: What drives them, and how that can change?

Recent comments by U.S. Navy Secretary Carlos del Toro have reignited a long-running issue of contention between Department of Defense officials and the management of the largest publicly traded defense prime contractors — stock buybacks. Specifically, some senior DOD officials have raised concerns when companies that are doing business with the DOD use remaining capital to buy back existing shares of company stock in lieu of additional investments in research and development, or production capacity .

The secretary is rightly focused on the need for increased investment to facilitate greater innovation and production capacity for strategic competition with China. The management teams of some large defense primes, on the other hand, buy back shares as an efficient way to return value to shareholders after considering the attractiveness of investment opportunities available to the company.

Changing this situation and spurring increased investment in the defense market requires addressing the incentive structures that guide market behavior, including stock buybacks.

Before examining market incentives, it is worth noting that the U.S. government decided many decades ago to largely privatize the defense-industrial base . While the DOD retains a modest number of government-owned arsenals, shipyards and depots, the vast majority of the systems developed and services conducted for the DOD are performed by for-profit companies. These companies have developed the innovations and capabilities that have made U.S. forces the best in the world.

This industrial base includes approximately 200,000 small, medium and large companies , the vast majority of which are privately held. Including those traded on foreign exchanges, there are only about 100 companies that are publicly traded. And only a very small fraction of those companies use share buybacks consistently as a strategic management tool.

Secretary del Toro captures the essence of the anti-buyback argument, which has been articulated by Pentagon leaders for years: “You can’t be asking the American taxpayer to make even greater public investments while you continue, in some cases, to goose your stock prices through stock buybacks, deferring promised capital investments, and other accounting maneuvers.”

Why do defense companies continue to pursue stock buybacks? It is principally the large mature defense primes such as Lockheed Martin, Northrop Grumman and HII that buy back stock. These firms are profitable , generate significant cash flow, have a relatively low cost of capital and are not highly leveraged.

Lack of capital is not a problem hindering investment at the largest defense primes. The issue revolves around the capital allocation decision. If large defense primes are not making significant investments, it is because they believe that this incremental dollar is unlikely to materialize into a profitable contract in the future. For that to change, these primes need to see a better return for the earnings they intend to retain and reinvest. Those returns could come through an increased number of growth opportunities, a greater frequency and volume of competitions, or margin improvement.

In contrast to the large mature primes, smaller publicly traded companies such as AeroVironment and Kratos do not typically buy back shares. They are instead investing in growth, as they see significant opportunities in their own market segments and beyond as the DOD spends heavily in unmanned systems, advanced electronics, autonomy and other areas central to the National Defense Strategy. If similar, larger incentives existed for the larger primes, then that is where capital would be allocated.

Bigger budgets obviously help incentivize investment, but changing how the DOD buys through practices such as open architectures , multiyear contracts and multiple production lines will likewise create more contract opportunities and therefore that stronger demand signal that industry needs to invest.

The DOD is heading in that direction in several important ways, and more emphasis there would be productive. Adopting some of the recent recommendations of the congressional commission on defense planning, programming, budgeting and execution reform, for example, could substantially contribute toward improving incentive structures.

Another promising avenue the DOD can use to incentivize investment by the larger primes revolves around program performance. Secretary del Toro has justly emphasized in his recent remarks that “industry must deliver platforms and capabilities on time and on budget for the sake of our warfighters who are in harm’s way.”

How about, for example, rewarding contractors with substantial profit-margin expansion opportunities for delivering ahead of terms, and punishing them more severely for missing the mark? The beauty of a commercially viable defense industry is that its participants are responsive to incentives.

Ultimately, management at for-profit companies are stewards of others’ capital. Browbeating the financial practices of industry alienates firms large and small. Let’s work instead to change some of the incentive structures in the defense market. Addressing these will help foster the innovation and investment we need in our industrial base as well as reducing stock buybacks along the way. And it is ultimately that vibrant public-private partnership we need to confront today’s daunting national security challenges.

Jerry McGinn is the executive director of the Greg and Camille Baroni Center for Government Contracting at George Mason University and a former senior U.S. Defense Department acquisition official. Mikhail Grinberg is a partner at Renaissance Strategic Advisors and a member of the center’s advisory board. Lloyd Everhart is a research manager at the center.

美国海军部长卡洛斯·德尔·托罗最近的言论再次引发了国防部官员与最大的上市国防承包商管理层之间由来已久的争论——股票回购。具体而言，一些国防部高级官员对与国防部有业务往来的公司将剩余资金用于回购现有股票，而不是用于研发或产能提升等额外投资表示担忧。

这位部长正确地强调了增加投资以促进创新和提升生产能力，从而应对与中国的战略竞争的必要性。另一方面，一些大型国防企业的管理团队在权衡公司可利用的投资机会后，会选择回购股票，以此作为向股东返还价值的有效途径。

改变这种局面，刺激国防市场增加投资，需要解决引导市场行为的激励机制，包括股票回购。

在探讨市场激励机制之前，值得注意的是，美国政府早在几十年前就决定将国防工业基础大幅私有化。虽然国防部保留了少量国有军火库、造船厂和仓库，但绝大多数为国防部开发的系统和服务都是由营利性公司提供的。正是这些公司开发了创新技术和能力，使美军成为世界上最强大的军队。

该产业基地包含约20万家大中小企业，其中绝大多数为私营企业。若包括那些在海外交易所上市的企业，则仅有约100家公司是上市公司。而这些上市公司中，只有极少数会持续地将股票回购作为一项战略管理工具。

德尔托罗部长抓住了反对股票回购论点的精髓，五角大楼领导人多年来一直阐述这一论点：“你不能一边要求美国纳税人进行更大的公共投资，一边在某些情况下继续通过股票回购、推迟承诺的资本投资和其他会计手段来推高股价。”

为什么国防公司持续进行股票回购？主要是像洛克希德·马丁、诺斯罗普·格鲁曼和HII这样的大型成熟国防巨头在进行股票回购。这些公司盈利能力强，现金流充裕，资本成本相对较低，而且杠杆率不高。

资金短缺并非阻碍大型国防承包商投资的根本问题。问题的关键在于资金配置决策。如果大型国防承包商不愿进行大量投资，那是因为他们认为这笔额外的资金未来不太可能转化为盈利合同。要改变这种状况，这些承包商需要看到其计划留存并再投资的收益获得更高的回报。这些回报可以通过增加增长机会、提高竞标频率和规模，或提升利润率来实现。

与大型成熟的公关公司不同，像AeroVironment和Kratos这样的小型上市企业通常不会回购股票。相反，它们将资金投入到增长中，因为它们看到了自身市场领域以及其他领域的巨大机遇，尤其是在美国国防部大力投资无人系统、先进电子设备、自主系统以及其他对国家国防战略至关重要的领域。如果大型公关公司也能获得类似的、更大的激励，那么资金就会流向它们。

更大的预算显然有助于激励投资，但通过开放式架构、多年合同和多条生产线等做法改变国防部的采购方式，同样会创造更多的合同机会，从而发出更强烈的需求信号，表明行业需要投资。

国防部正朝着这个方向迈进，并在几个重要方面加大投入，这将卓有成效。例如，采纳国会国防规划、方案制定、预算编制和执行改革委员会近期提出的一些建议，将有助于显著改善激励机制。

国防部可以用来激励大型主承包商投资的另一个有前景的途径是围绕项目绩效展开。德尔·托罗部长在最近的讲话中正确地强调，“为了我们身处险境的作战人员，工业界必须按时按预算交付平台和能力。”

例如，我们可以奖励那些提前交付的承包商大幅提高利润率，并对未能按时交付的承包商处以更严厉的惩罚，这样如何？一个商业上可行的国防工业的优势在于，其参与者会对激励措施做出积极响应。

归根结底，营利性公司的管理层是他人资本的管理者。一味地强硬行业财务做法会疏远大大小小的公司。我们应该努力改变国防市场的一些激励机制。解决这些问题将有助于促进我们工业基础所需的创新和投资，同时也能减少股票回购。而最终，我们需要的正是这种充满活力的公私合作关系，才能应对当今严峻的国家安全挑战。

杰瑞·麦金是乔治·梅森大学格雷格和卡米尔·巴罗尼政府合同中心执行主任，曾任美国国防部高级采购官员。米哈伊尔·格林伯格是文艺复兴战略顾问公司的合伙人，也是该中心顾问委员会成员。劳埃德·埃弗哈特是该中心的研究经理。