Edition: U.S. / Global

The High Cost of an Arms Scandal

Published: July 10, 1988

MILITARY contractors are certainly no strangers to scandal. Over the years, they have admitted to falsifying time cards, bribing foreign politicians, even selling the Government $435 hammers. But industry executives, analysts and other experts believe that the Pentagon fraud and bribery investigation now underway is likely to have far broader - and more ominous - implications for weapons makers than any previous misdeeds.

Already, before a single company or individual has been indicted, the case is creating widespread fallout that is sure to affect the industry's fortunes. While specific allegations of wrongdoing are still few and there is no way to know how the investigation will turn out, military contractors are now contemplating the many ways in which their $80 billion industry could be hurt or reshaped:

* A number of companies could be barred - temporarily or permanently - from getting new Pentagon business, perhaps changing the scope of competition in some industry segments.

* Some big contracts, such as the Navy's Advanced Tactical Aircraft, could be overturned and bidding reopened, giving companies that lost out another crack at multi-billion-dollar projects.

* Companies found guilty of wrongdoing might be punished by being forced to complete projects at no profit.

* Scores of companies face the likelihood of having some payments withheld by the Pentagon while dozens of contracts are under investigation. Indeed, payments have already been stopped on nine contracts, encompassing more than 100 companies, although there is considerable confusion in the Pentagon as to how the suspensions are to be carried out and even whether there is legal justification for the action. While the financial impact of widespread or lengthy payment suspensions is impossible to gauge now, some analysts think it could be significant.

* The industry's efforts to get Congress to ease up on what it considers onerous, restrictive procurement policies are likely to falter.

* Penalties for fraud could be increased by Congress and the entire procurement process could be overhauled, forcing changes in the way the industry goes about competing for contracts and dealing with the Pentagon.

* Congress may prove less willing to fund future weapons programs at a time when Pentagon spending is already declining.

* Stock prices for aerospace and military electronics companies, which were sagging even before the scandal erupted last month, could sink deeper.

* Any harsher contracting terms resulting from the scandal could weaken some companies financially, affecting their ability to maintain their technical prowess and perhaps accelerating a trend towards mergers and industry consolidation.

* Costly legal battles could erupt among companies, their shareholders, the Government and other companies.

''It's terribly damaging,'' said Weyman Jones, a vice president of the Grumman Corporation, one of the few major aerospace companies that has not been linked to the investigation. ''It's a big deal because it comes hard on a time of difficult relationships between the industry and its customer, and at a time when it looked like there was some relief in sight.''

By its nature, the military contracting industry is as much a political creature as an economic entity. ''The customer'' - the Government - determines the industry's health through a sometimes unfathomable process combining pork-barrel politics with changing technology, global events and considerations of national security. Through the Cold War era, Vietnam and the Reagan years, it has become one of the nation's largest businesses, with 3 million private-sector workers and a huge network of giant companies, smaller subcontractors and tiny suppliers.

THE companies linked to the investigation include some of the nation's largest contractors. Among them are the McDonnell Douglas Corporation, the Northrop Corporation, the United Technologies Corporation and the Unisys Corporation. Dozens of other companies have also been linked to the probe, at least peripherally. None has been charged with any crimes. As many as 85 contracts, with a total value still unknown, are under scrutiny. Many appear to be Navy programs, but Justice Department officials said the investigation also encompasses the other services.

If nothing else, the scandal - which focuses on the possibility of bribery, bid-rigging and the passing of ''inside information'' among Pentagon officials, industry consultants and companies - already has wiped out much of the progress the industry has made in recent years to eradicate its image as a hotbed of fraud and waste, members of Congress and industry executives said.

It is a bad time for the industry to lose friends. The arms buildup of the first Reagan term has given way to flat or declining Pentagon budgets as Congress struggles to cut Federal budget deficits. Fewer new weapons programs are on the drawing boards. Companies will have to compete more intensely, accept lower profit margins and risk more of their own money to win contracts. Key segments of the business, including aircraft assembly and shipbuilding, already are plagued by overcapacity. Under the Reagan Administration, the business has become much less monopolistic, with companies often forced to compete head to head for contracts. Many experts say this change created the atmosphere in which companies would seek inside information through consultants to win contracts.