Maintaining a Healthy U.S. Defense Industrial Base: Risk Sharing and Contract Design in the Major Defense Acquisition Program Setting

Abstract

The United States faces an escalating threat from great-power competition, placing new demands on the Defense Industrial Base (DIB). Although the DIB has historically delivered the capabilities needed to deter and defeat adversaries, major defense contractors have recently expressed reluctance to participate in fixed price contracts for Major Defense Acquisition Programs (MDAPs), citing an inequitable allocation of risk. If unresolved, this challenge risks undermining both the health of the DIB and the nation’s warfighting readiness. This thesis examines the root causes of misaligned risk-sharing and conflicting incentives between the government and the DIB in MDAPs and evaluates a range of risk-management and incentive-alignment approaches, including enhanced program-management practices and redesigned incentive structures. Drawing on economic theory, particularly agency theory involving information asymmetry and moral hazard, it analyzes current acquisition programs and relevant literature on incentive design and industrial-base resilience. The thesis proposes an alternative profit function and contract-design framework that better aligns firms’ profit-maximization incentives with the government’s objectives of cost control and truthful cost estimation. The findings suggest that a more balanced approach to risk allocation is essential to sustaining the competitiveness and strategic effectiveness of the U.S. Defense Industrial Base.