Exec pay restrictions swaying defense sector outlook—despite still-unclear impact

Terry Gerton I know you’ve been tracking how the new limits on executive pay and dividends and other financial levers are landing across the defense sector. Now that we’re a little bit removed from that announcement, what, if anything, are you seeing in defense stock performance?

Paul Murphy Well, Terry, let’s back up a second and just refresh people’s memory. We’re talking about this executive order that hit back in January, right before earnings season, as it turns out. Prioritizing the warfighter in defense contracting. And it allows Secretary Hegseth to restrict stock buybacks, dividends, certain types of executive compensation through future defense contracts. It doesn’t impose explicit universal compensation caps, but it’s requiring these terms to be embedded in contracts. So it’s not going to be anything that’s that’s criminal or regulatory in nature. It’s going to be contract-based, so it’s it’s future-oriented. So really, since it hit in January, it hit before earning seasons and a lot of the companies had already been reporting about dividend payments back in the October-December time frame. We really haven’t seen a big hit in the defense industry just yet and the stocks are fairly stable. In fact, the big primes toward the end of the year, several of them were reporting record revenues for last year. As you’ve seen, a lot big-ticket opportunities, contracts are hitting right now. And so the defense market is looking pretty strong.

Terry Gerton One of the open questions about that compensation cap might be on a company’s ability to recruit and keep senior tech talent. Are you seeing any kind of response to that in terms of movement and retention or morale or hiring at these firms?

Paul Murphy Again, it’s still a little early. You know, at the Davos meeting in Switzerland, the big international financial meeting, Treasury Secretary Bessent lambasted defense executives, saying their companies have let the American people down, they’re years behind on their contracts when CEOs are making $30 million to $50 million a year. There’s likely, you know, some discomfort at the executive level. But we aren’t seeing people heading for the exits just yet. The EO targets the C-suite — the CFOs, CEOs — but it’s largely avoiding the mid-tier, the higher-paid engineers at these companies. So it may have a long-term cultural effect in terms of the kinds of incentives they can offer the salaried employees and the higher-level tech talent. And if that’s the case, we may see engineers being more attracted to civilian opportunities in the coming months. But so far, nobody, none of the companies have been cited for underperformance. I understand early reports are that they are in negotiations with some companies that have been reported to be underperforming. I mean, Lockheed had a big issue with the Lot 15 F-35s, and President Trump explicitly called out RTX first-load delivery of the Patriots, but apparently they’re in negotiations about some of these problems. And you see Secretary Hegseth was right there in St. Louis this week, touting Boeing’s move to St. Louis out of Arlington, and so I think they are trying to help these defense contractors succeed. They’re not doing, right now, a lot of the underperformance announcements that the executive order called for.

Terry Gerton So you think the companies are taking kind of a wait-and-see approach to perhaps restructuring senior compensation models or other sorts of getting ahead of this?

Paul Murphy Because it’s contract-focused, as we just discussed, it gives the Defense Department a lot of leverage over how these negotiations play out. It’s not a universal, across-the-board cap on salary or cap on profits or you can’t issue dividends. I think companies obviously are still issuing dividends, and I haven’t seen major announcements of stock buybacks in the last two or three months, but so far there doesn’t seem to have been a major change in corporate behavior or in employee behavior.

Terry Gerton I’m speaking with Paul Murphy. He’s a senior data analyst at Bloomberg Government. Well, Paul, let’s shift our angle just a little bit and talk about another segment of government buying around the value added resellers. This was another big topic towards the end of last year. The administration’s been very intentional and a little provocative with the VARS. What are you hearing there in terms of how their behavior is starting to change?

Paul Murphy Well, I have my nose in a lot of the data. I’m not the ones necessarily chasing the politicians down the hallway, but we do study the data a lot. And what we’re seeing in the data is that larger and fewer contracts are going to larger and fewer companies. That’s a continuing trend. And the OEM decision to negotiate directly with OEMs, original equipment manufacturers, for the supply of software and is, I think, a big part of this. And we just saw this big award back in January that the Army took Salesforce’s Computable Insights subsidiary from a $99 million contract to a $5.6 billion contract. And in the process, they have bypassed the scores of resellers and VARs in the Salesforce network. This is going to have a significant impact on IT VARs that sold things like Slack, for instance, one of Salesforce’s premier products. And it’s going to concentrate the sales within the manufacturers. It’s a boon to companies like Salesforce. But one of the big losers in this was Carahsoft, which is a big reseller of Salesforce. And so they’re going to have to look for other opportunities. They’re going have to continue making the case for reselling to the government. Industry critics are saying that the concentration of the sales power within the OEMs could have deleterious effects down the road because of potential monopoly pricing and a reduction of competition…once the government buys into a single platform with a single company, it gives that company a lot of leverage. So it may appear competitive and important for streamlining and efficiency in the short run, but down the road, the concentration of financial power within fewer companies generally has the effect of reducing competition and impacting pricing, which in turn can lead to less value for taxpayers. It could lead to other effects — the inability to buy necessary equipment with the resources that they have to spend for higher-priced goods and services.

Terry Gerton Part of the discussion around how the government is changing the way it buys is to build resiliency into the supply chain. This sounds like it’s actually making the supply chain more fragile.

Paul Murphy When you concentrate supply in fewer hands, it makes it more fragile. It reduces the amount of competition in the system. It can have that effect, yes.

Terry Gerton So you mentioned this particular buy out of the Defense Department. How is that part of the broader OneGov strategy at GSA?

Paul Murphy Well, one by one, GSA is approaching a lot of these major IT suppliers — Google, Microsoft and many others — to bypass the VARs, with the idea in mind that products and product-related services can be procured directly from the companies. And there’s about, I counted 20 OneGov contracts profiled on GSA’s webpage. And that may not even be all of them, because there’s another what they call classifying as a OneGov contract with with Salesforce that didn’t actually appear on the site the last time I checked. It’s a strategy that could backfire; VARs traditionally hold the pricing risk. They negotiate volume discounts. Removing them from the supply chain gives the OEM the pricing power, particularly for software. So even though the Pentagon’s acquisition reforms encourage direct supplier deals, the model looks like it’s going to expand and could lead to higher prices down the road.

Terry Gerton So you watch this kind of data all the time. What pieces of data do you have your eye on to kind of tell you where these trends are going to be moving in the short run?

Paul Murphy Well, we’re watching every day the opportunity notices, and we’re watching particularly for single-source agreements with companies. We’re watching announcements about OEMs and OneGov announcements with OEMS. We are tracking the contracts data very closely. We are seeing trends away from, for instance, small business contracting and socioeconomic set-asides. There’s been a lot of pressure on the 8(a) program, which through 8(a) STARS and other contracts, has been a significant contributor to competition in the IT and professional services space. But that’s where we happen to be seeing the most decline in the number of contractors participating in the federal space. So I think the overall decline in numbers of market participants over time will have a deleterious effect on competition and pricing.