INCENTIVES IN DEFENSE CONTRACTS WERE INTRODUCED IN THE 1960'S IN AN EFFORT TO REDUCE COST OVERRUNS IN THE COST-PLUS CONTRACTS. COST-PLUS CONTRACTS OBLIGATED GOVERNMENT TO PAY FOR INCREASES IN COST VARIABLES BEYOND TARGET COST. A COST OVERRUN UNDER AN INCENTIVE CONTRACT, ON THE OTHER HAND, IS ONLY PARTLY PAID BY GOVERNMENT, WHO WOULD PRESUMABLY PROVIDE AN INCENTIVE TO REDUCE COST OVERRUNS. FURTHER, UNDER SOME INCENTIVE CONTRACTS, THE FIRM EARNS A FEE FOR EXCEEDING THE PERFORMANCE AND/OR DELIVERY TIME TARGETS. EMPIRICAL DATA INDICATE THAT COST PERFORMANCE RELATIVE TO TARGET COSTS HAS IMPROVED UNDER THE INCENTIVE MEASURES; HOWEVER, THESE DATA DO NOT TAKE INTO ACCOUNT THE TOTAL COSTS EXPENDED UNDER INCENTIVE CONTRACTS AS COMPARED WITH COST-PLUS CONTRACTS. BY ONLY COMPARING THE RELATION BETWEEN TARGET COSTS AND ACTUAL COSTS UNDER INCENTIVES, THE POSSIBILITY OF THE INCENTIVE SYSTEM PRODUCING HIGHER TARGET COSTS AND HIGHER PROFIT RATES, ALONG WITH FEES FOR EXCEEDING PERFORMANCE AND TIME TARGETS, IS IGNORED. ALL OF THE AFOREMENTIONED VARIABLES MUST BE CONSIDERED BEFORE THE TOTAL COST REDUCTIONS UNDER THE INCENTIVE SYSTEM CAN BE AFFIRMED. A COMPARATIVE ANALYSIS OF ACTUAL COST-PLUS AND INCENTIVE CONTRACTS OVER THE LAST 3 DECADES, TAKING INTO ACCOUNT INFLATION, SHOWS THAT TOTAL COSTS TO THE GOVERNMENT HAVE INCREASED SLIGHTLY UNDER INCENTIVE CONTRACTS. THIS SUGGESTS THAT CONTRACTORS HAVE INCREASED TARGET COSTS, WHILE PRODUCTION EFFICIENCY HAS REMAINED AT ABOUT THE SAME LEVEL AS UNDER COST-PLUS CONTRACTS. TABULAR DATA AND FOOTNOTES ARE PROVIDED. (RCB)