Congress should walk Trump's talk on arms industry stock buybacks

The Trump administration’s new executive order to curb arms industry stock buybacks — which boost returns for shareholders — has no teeth, but U.S. lawmakers could and should take advantage.

The White House issued an Executive Order on Jan. 7 to prevent contractors “from putting stock buybacks and excessive corporate distributions ahead of production capacity, innovation, and on-time delivery for America’s military." The order empowers the Defense Secretary to "take steps to ensure that future contracts prohibit stock buybacks and corporate distributions during periods of underperformance, non-compliance, insufficient prioritization or investment, or insufficient production speed."

The administration is right to call attention to military contractors getting rich on the taxpayer’s dime, but Congress has the constitutional authority to regulate commerce and control federal funding, not the president.

He could certainly encourage voluntary compliance with the order by recommending that Congress cancel or withhold contracts from firms delivering what it considers excessive stock buybacks, shareholder dividends, and executive compensation. But President Trump proposed a $1.5 trillion Pentagon budget on the same day he released his executive order, and he remains committed to a “peace through strength” agenda partly characterized by the expensive pursuits of military and technological dominance. The $1.5 trillion budget proposal is reason enough for military contractors to call the president’s bluff.

What's more, the defense industrial base cannot absorb a $500 billion plus up to the Pentagon budget. It’s a small industry with a limited number of major players and workers. Should Congress approve a $500 billion increase in a single fiscal year — through the reconciliation process, if at all — it would further cement existing incentives for contractors to develop poorly designed, unreliable, and overly expensive weapon systems. The Pentagon would hastily award lucrative contracts to firms eager to answer the president’s call for a greater rush to production.

The president’s executive order will likely amount to a flashy political stunt, but lawmakers can take meaningful action against shareholder-first business practices in an industry so reliant on government contracts. The most obvious action is to reduce weapons purchases, making it cost-prohibitive for contractors to continue prioritizing shareholders over everything.

Short of a reduction in weapons procurement spending, it would be bold for lawmakers to challenge contractors’ financial positions by instituting caps on authorized but unissued stock, what’s traditionally known as “treasury stock.” If a publicly traded military contractor was limited to owning a certain percentage of its own stock, its board would have lesser ability to manipulate common stock prices during downturns caused by poor contract performance or geopolitical tumult.

Lawmakers could further narrow the applicability of these caps by limiting them to contractors that generate a certain percentage of their revenues from government contracts.

Another option is for Congress to further reduce the tax advantage of repurchasing stock instead of issuing dividends to investors. Buybacks are relatively tax efficient because they are tax deferred. Investors pay capital gains when they sell the stock, whereas dividends are taxed as income. The Inflation Reduction Act of 2022 established a 1% excise tax on stock buybacks exceeding $1 million, which the Joint Committee on Taxation estimated will generate $74 billion in revenue from fiscal years 2022 to 2031. At the time, there was Democratic support for an excise tax of 4%, which would vastly reduce the tax incentive for contractors to repurchase shares.

Realistically, the most viable path for Congress to rein in arms industry stock buybacks is to be specific about its expectations for military contractors — and most importantly, issue penalties when contractors fail to meet those expectations. As previously mentioned, the government can refuse contracts to companies already behind schedule and over budget on existing programs. If firms risk future ineligibility for Pentagon contracts, it might encourage them to share honest cost estimates during the bidding phase — when contractors so often underestimate cost projections to win contracts.

Congress can also disqualify firms from future contracts if they repeatedly refuse to provide the Pentagon with the cost information necessary for the department to negotiate fair prices, particularly with sole-source suppliers. Data denials are a well-documented, persistent issue in the arms industry, yet contractors continue to get away with them.

At the end of the day, talk is cheap, but meaningful legislative action can change contractors’ financial incentives long-term. This is critical to holding firms accountable to their contractual commitments and the president to his word, especially given the administration’s recent investment in L3Harris.

Partial government ownership can offer public officials greater opportunity to cash in on government contracts, as reduced risk boosts a firm’s valuation. But it can also shift a firm’s focus away from shareholder returns and toward investment, should the government effectively leverage its financial stake — which ideally comes with board representation and voting rights.

Should it choose to take it, Congress has an important opportunity to shape the outcome of these partnerships and to curb industry buybacks more generally.