President Trump issued an executive order last week granting Defense Secretary Pete Hegseth unprecedented authority to dictate executive compensation structures at military contractors, raising questions about government overreach into private sector pay decisions.
Why it matters: Defense contractors today, all federal contractors tomorrow?
The compensation implications: The order aims to use compensation to “stop defense contractors from putting stock buybacks and excessive corporate distributions ahead of production capacity, innovation, and on-time delivery for America’s military.”
- The Order directs the Secretary of Defense, within 60 days, to ensure all future contracts prohibit buybacks and dividends for “underperforming” defense contractors.
- These contracts must also stipulate that incentive compensation not be tied to short-term metrics like free cash flow or “earnings per share driven by stock buybacks,” requiring operational metrics such as on-time delivery and increased production.
- If a company is deemed to be underperforming (as defined by the Secretary), the contract must allow Secretary Hegseth to freeze executive base salaries.
- The Order also directs SEC Chair Gensler to consider denying “underperforming” defense contractors the use of stock buyback safe harbor under Rule 10b5-1.
What's uncertain: The order provides no clarity on critical compensation questions, including whether restrictions apply to all C-suite roles or how long-term incentives are affected. Nor does it define underperforming companies.
Between the lines: Trump's social media posts last week promised a blanket $5 million salary cap. The actual order is more nuanced but potentially more disruptive—it effectively makes the Defense Secretary a compensation committee member for any contractor seeking future contracts.
More insights: Yale law professor Harold Koh warns the order inappropriately "puts the Secretary of War into the shoes of the Securities Exchange Commission."
The bottom line: As an excellent Holland & Knight analysis points out, this order “moves beyond traditional performance oversight and into direct intervention in corporate governance, capital allocation and executive compensation. The speed, subjectivity and severity of the new regime require immediate attention.”
