President Trump issued an Executive Order (“EO”) on January 7, 2025, that seeks improved performance of defense contracts and enhanced contractor investments in production capacity through measures that would impose limits on executive compensation when contractor performance or investment levels are deemed inadequate. The EO, Prioritizing the Warfighter in Defense Contracting, appears predicated on the belief that “after years of misplaced priorities, traditional defense contractors have been incentivized to prioritize investor returns over the Nations’s warfighters.” To address this, the EO states that “[m]ajor defense contractors will no longer conduct stock buy-backs or issue dividends at the expense of accelerated procurement and increased production capacity.” While the desire to improve defense contract performance is understandable, the attempt to do so through regulation of executive compensation is unprecedented.
What Does the EO Require?
The EO sets forth two key mechanisms through which the new priorities will be implemented.
- Notifications to defense contractors for critical weapons, supplies, and equipment
Within 30 days of EO issuance (February 6, 2026), the Secretary of War (the “Secretary”) must identify any defense contractors for critical weapons, supplies, and equipment that, while “engaged in any stock buy-back or corporate distribution,” are:
- underperforming on their contracts,
- not investing their own capital into necessary production capacity,
- not sufficiently prioritizing United States Government contracts, or
- whose production speed is insufficient.
The Secretary must notify such contractors of “the nature of the underperformance or insufficient prioritization, investment, or production speed.” A notified contractor would have 15 days to submit a remediation plan approved by its board of directors. The EO provides that if the Secretary is unsatisfied with the remediation plan or the parties are unable to resolve the issues during the “relevant 15-day negotiation period,” the Secretary may seek available enforcement actions under the Defense Production Act and contract enforcement actions under the FAR and DFARS. The EO is unclear as to whether the 15 days the contractor is afforded to submit a remediation plan and the 15-day negotiation period are distinct, consecutive periods. The EO also provides that contractors notified of underperformance or insufficient prioritization, investment, or production speed may be subject to withdrawal or denial of Department of Defense (“DoD”) support in competition for international sales—Foreign Military Sales and Direct Commercial Sales.
- New contract terms
Within 60 days of EO issuance, any future contract with new or existing defense contractors, including any renewal, must contain a provision:
- prohibiting both any stock buy-back and corporate distributions by the contractor during a period of underperformance, non-compliance with the contractor’s contract, insufficient prioritization of the contract, insufficient investment, or insufficient production speed;
- requiring that contractor executive incentive compensation not be tied to short-term financial metrics, such as free cash flow or earnings per share driven by stock buy-backs, and instead be linked to on-time delivery, increased production, and necessary facilitation of investments and operating improvements required to rapidly expand United States stockpiles and capabilities; and
- requiring that, when a contractor has engaged in underperformance, non-compliance with the contractor’s contract, insufficient prioritization of the contract, insufficient investment, or insufficient production speed, the contractor’s executive base salaries be capped at current levels, with increases allowed for inflation, consistent with applicable law, for a time period sufficient to allow the Secretary to scrutinize the incentive portion of executive compensation to ensure it is directly, fairly, and tightly tied to the above metrics.
3. SEC role
To facilitate the administration’s objective to use executive compensation restrictions to incentivize enhanced contractor performance and investment, the EO requires the Chairman of the Securities and Exchange Commission (“SEC”) to consider whether to adopt amended regulations governing stock buy-backs under Rule 10b-18 that would prohibit use of the relevant safe harbor for defense contractors for critical weapons, supplies, and equipment.
Takeaways
- The government has long had mechanisms to address inadequate contractor performance, including payment withholds, negative performance reviews that can make it more difficult to receive future contracts, terminations for default, and even suspension and debarment in extreme cases. This EO seeks to add new mechanisms focused on DoD oversight of executive compensation.
- The EO contains no defined terms and, as a result, it is not clear which defense contractors will be impacted by potential notifications that are to begin within 30 days of the EO. The EO refers to “defense contractors for critical weapons, supplies, and equipment” without defining the weapons, supplies, and equipment covered.
- The new contract provision mandated by the EO could impact many defense contractors, as the EO states that it is to be included in future contracts with “any new or existing defense contractor.” It is unclear whether the requirement to include the new contract provision in any contract “renewal” is intended to cover exercise of contract options. It is also unclear whether the provision will contain flow-down requirements
- The EO’s directive for the new contract provision to address contract performance issues—through prohibition of stock buy-back and corporate distributions, dictating the metrics for executive incentive compensation, and freezing current executive base salaries other than increases for inflation—is unprecedented. While the government has in recent years limited executive compensation for purposes of cost allowability, the government has never attempted to oversee and restrict its contractors’ financial operations in this manner. Its authority to do so is questionable.
- While contract performance can be assessed based on the terms of the contract, the EO does not specify how contractor prioritization and investment levels are to be assessed. This would need to be addressed in the new contract provision.
- Contractors who are concerned that their executive incentive compensation systems may contain metrics at odds with the EO should consult with legal counsel.