The relation between cost shifting and segment profitability in the defense-contracting industry.

Accounting Review, October, 2002 by Annie S. McGowan

I. INTRODUCTION

In the mid-1980s, the General Accounting Office confirmed that defense contractors earned a higher return on assets (ROA) on their defense work than on their commercial business (Carrington 1986; Trueger 1991). Lichtenberg (1992) finds that the ROA of industry segments with government contracts is 68-82 percent higher than the ROA of commercial segments. Prior researchers argue that cost shifting is at least partly responsible for the defense-contracting industry's excess profits (Rogerson 1992; Thomas and Tung 1992). We test the hypothesized relation between cost shifting and defense-contractor excess profits by comparing the relative profitabilities (ROAs) of three segment types in defense-contracting firms: commercial segments (those with only...