Firm Performance in Regulated Markets: The Case of Spanish Defence Industry

ABSTRACT

This paper studies the effects of legal reforms associated with defence and public procurement on firm performance. With this aim, a theoretical framework for the reaction of defence firms to regulatory changes is developed. Its predictions have been empirically assessed using the last reforms implemented in Spain. Our results suggest that these new regulations have allowed the main defence contractors to outperform the other defence contractors in terms of productivity, having no effect on profitability. These findings are in line with theoretical priors. Therefore, it can be claimed that governmental interventions have had an effect on firm performance. We also provide evidence that, while the procurement procedures and the contract law put into place in 2011 have principally affected the productivity of large firms, the centralization process established in 2014 has exerted a higher influence on SMEs.

KEYWORDS:

• Defence industry
• public procurement
• regulated markets
• firm performance

JEL CLASSIFICATION:

• H57
• K23
• L64.

Acknowledgments

We are grateful to two anonymous referees, LtC Juan Manuel González del Campo from the Foresight and Technology Strategic Unit, Patrick Alexander and participants at 12th Defence and Security Economics Workshop in Carleton University, Spanish Economic Association Meeting in Getafe and DESEi+d in Valladolid for helpful suggestions and comments.

Disclosure Statement

No potential conflict of interest was reported by the authors.

Notes

1. The countries involved were France, Germany, Italy, Spain, Sweden, and the United Kingdom (U.K.).

2. 2004/551/CFSP Council Joint Action on the establishment of the European Defence Agency.

3. In this respect, and on a voluntary basis, a code of conduct on defence procurement was introduced in July 2006. This inter-governmental non-binding regime tried to increase the `subscribing Member States’ commitment to ensure fair and equal opportunities in all defence procurement contracts over one million euros where the conditions for application of article 296–346 of the Lisbon Treaty – were met. The exceptions were procurement of research and technology, collaborative procurements, and procurements of nuclear weapons and nuclear propulsion systems, chemical, bacteriological and radiological goods and services, and cryptographic equipment. This code of conduct was subscribed by Spain in July 2007, see https://www.eda.europa.eu/docs/documents/CoC.pdf

4. COM(2016)950. European Defence Action Plan.

5. COM(2013)542. Towards a more competitive and efficient defence and security sector.

6. Contractors are firms that provide procurement service to the Ministry of Defence.

7. For an overview, see ministerial orders DEF/1453/2010, that regulates defence R&D projects, and DEF/685/2012, on R&D for weapon systems.

8. At the same time that these problems are present in this market segment, they can be of small magnitude or even non significant for many commodities required by the armed forces. We are grateful to the referee to draw our attention to this relevant disctintion.

9. The reform implemented a new purchasing policy inspired by the `smart procurement’ introduced in the U.K.

10. Nonetheless, the 2008 economic crisis has negatively affected R&D defence expenditures (both public and private), see Ortega, Gamella, and Moya (2012).

11. Instruction 67/2011, article 9.

12. Adhering to this code of conduct has been voluntary. Nonetheless, it could become mandatory for any company wishing to enter into a contract with the Ministry of Defence, depending on sector needs and the industrial strategy eventually adopted. Additionally, in accordance with the Directive 2009/81/EC, the main clauses of the code of conduct became compulsory (García Montaño 2015a).

13. Similarly, Soriano Forte (2016) finds a positive trend in open biddings for the 2008–2015 period.

14. The performance of firms before and after the legal reform can be then tested empirically.

15. Given the price set by the Ministry of Defence, demand for procurement and the final cost of the product, maximum affordable research cost can be determined by each firm.

16. https://www.defensa.gob.es/ministerio/organigrama/sedef/dgam/

17. The classification used is NACE, rev. 2.

18. We are grateful to one anonymous referee referee for drawing our attention to this interpretation.

Additional information

Funding

This work was supported by the Ministry of Education and Science through grants ECO2016-76255-P and ECO2017-86305-C4-2-R, RTI2018-095799-B-I00; Government of Aragón -Spain- and FEDER COMPETE (S52_17R) research group and the Defence University Centre Zaragoza grants 2017-21 and 2018-12.