The Relation between Cost Shifting and Segment Profitability in the Defense-Contracting Industry

Posted: 23 Nov 2002

See all articles by Valaria P. Vendrzyk

Valaria P. Vendrzyk

Virginia Polytechnic Institute & State University - Department of Accounting and Information Systems

Annie S. McGowan

Texas A&M University - Department of Accounting

Abstract

We test the conjecture from prior research that defense contractors' excess profitability in the 1980s stemmed from their ability to shift common overhead costs to government contracts that typically allow cost reimbursement or price renegotiation (Rogerson 1992; Thomas and Tung 1992; Lichtenberg 1992). Although we confirm prior evidence that defense contractors enjoyed abnormally high profitability on their government work in the 1984-1989 period (a period of relatively low competition for defense contracts), we find no evidence that this excess profitability is attributable to cost shifting. In addition, we find no evidence that Top 100 defense contractors (firms that likely wield above-average market power) are able to use cost shifting to exploit a lack of competition in the industry. Our results suggest that, contrary to the conjectures in prior research, the unusually high profitability reported on government contracts in 1984-1989 is more likely attributable to nonaccounting explanations than to cost shifting.

Keywords: cost shifting, defense contracting, competition

JEL Classification: M40, M46, H00, L00

Suggested Citation

Vendrzyk, Valaria P. and McGowan, Annie S., The Relation between Cost Shifting and Segment Profitability in the Defense-Contracting Industry. Available at SSRN: https://ssrn.com/abstract=311259

Valaria P. Vendrzyk (Contact Author)

Virginia Polytechnic Institute & State University - Department of Accounting and Information Systems ( email )

Pamplin College of Business
Blacksburg, VA 24061
United States
540-231-2527 (Phone)
540-231-2511 (Fax)

Annie S. McGowan

Texas A&M University - Department of Accounting ( email )

430 Wehner
College Station, TX 77843-4353
United States
979-845-2055 (Phone)
979-845-0028 (Fax)

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