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We examine whether contractors with cost plus contracts earn a higher profit, and whether the higher profit is associated with cost shifting behavior, using a unique set of data of federal procurement contracts between the years 2005 and 2010. Prior research often examines government contractor profitability without differentiating the contract types, which is a key determinant to the contractor’s ability to cost-shift. We identify firms that are awarded with cost plus contracts in some years and without in other years. We find their profitability significantly increases during the years that cost plus contracts are awarded. We also find that these firms exhibit greater discretionary expenditures during the years with cost plus contracts, relative to the years without, which is consistent with cost shifting behavior. However, effective monitoring through the Cost Accounting Standards helps mitigate such behavior.

Profitability and Cost Shifting in Government Procurement Contracts