Incentive Plan Design in the Defense Sector Faces Political Test

March 4, 2026

Amit Batish

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On January 7, 2026, President Donald Trump issued an executive order directing the Department of War to prohibit future federal contracts with defense companies that use short-term financial metrics in their executive incentive plans, while also limiting stock buybacks and dividends. The President criticized defense industry executive compensation as excessive and suggested capping pay at $5 million for leaders at these firms.

The timing of the order is notable. Given the months of mounting tensions, the eventual escalation of conflict in Iran and broader instability across the Middle East, defense contractors are at the center of national security discussions. As the U.S. leaves open the possibility of boots on the ground in Iran, attention is likely to intensify on defense companies and their executives to meet heightened operational demands, with production capacity and delivery timelines becoming increasingly critical.

The order also brings renewed attention to the structure of executive incentive plans within the defense sector, particularly the role of financial metrics such as free cash flow and earnings per share (EPS). These measures are commonly used in annual incentive programs to align management performance with profitability, capital allocation and shareholder returns. At the same time, critics argue that short-term financial targets may not always reflect longer-term operational readiness and strategic priorities.

In this analysis, Equilar examines the prevalence of defense companies that currently use free cash flow and EPS in executive pay plans.

Among Russell 3000 companies, just over one-quarter (27.5%) use either free cash flow or EPS in their executive incentive programs. Specifically, 13.1% incorporate free cash flow as a performance metric, while 18.5% use EPS.

Within the defense sector, however, the prevalence of these metrics is notably higher. A majority (57.1%) of defense companies use either free cash flow or EPS in executive incentive plans, more than double the rate observed across the Russell 3000. Breaking this down further, 42.9% of defense companies implement free cash flow, while 34.3% use EPS.

Company Group	Companies With
Russell 3000	13.1
Defense Companies	42.9

Company Group	Companies With
Russell 3000	18.5
Defense Companies	34.3

This elevated usage may reflect the capital-intensive nature of defense contracting and the importance of cash management in businesses tied to government processes. Free cash flow, in particular, can serve as a key indicator of a company's ability to manage working capital, fund research and development, and execute on large-scale contracts. EPS, meanwhile, remains a widely cited measure of profitability and earnings growth.

The executive order's focus on these short-term financial metrics raises important governance and design considerations for companies operating in the defense sector. As the President aims for these companies to move away from short-term goals that drive positive stock performance, the executive order states that executive incentive programs at defense contractors should be "linked to on-time delivery, increased production, and all necessary facilitation of investments and operating improvements required to rapidly expand our United States stockpiles and capabilities."

Industry leaders are already beginning to comply. Aerospace company Northrop Grumman has approved its annual executive incentive program, which includes changes that align with the executive order. In its 2025 program, the Company's non-financial metrics included 1) inclusion and belonging, 2) environmental sustainability, 3) quality and 4) customer satisfaction. For 2026, Northrop Grumman disclosed modifications to its plan to feature 1) quality, 2) customer satisfaction, 3) on-time delivery, 4) scaling/production capacity, 5) belonging and 6) sustainability. Points three and four use language directly from President Trump's executive order.

While the executive order directs the Department of War to implement specific contracting restrictions, the broader discussion may prompt defense companies, and possibly other sectors with significant federal exposure, to reassess how annual incentives are structured. Additionally, the suggested $5 million CEO pay cap for underperforming firms introduces another dimension to the debate on pay levels and performance alignment. Although details around implementation remain unclear, such proposals highlight the heightened scrutiny facing executive compensation in industries closely tied to public funding.

As policymakers intensify their scrutiny of how government contractors structure executive performance measurement, the defense sector's comparatively high usage of free cash flow and EPS positions the industry squarely within the spotlight. The full implications of the executive order issued by President Trump remain to be seen, particularly as implementation details emerge. As companies prepare for the upcoming proxy season, and the conflict in the Middle East persists, developments in this area will be worth monitoring.

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