Over 100 U.S. aerospace and defense industry executives are urging Defense Secretary Leon Panetta to hold off on proposed changes to Pentagon contracts with industry, warning they would dampen competition, raise costs and lead to further layoffs at a difficult time.

In a joint letter to Panetta dated November 28, the executives cited industry-wide concern about Pentagon efforts to make contractors bear more of the risk of new weapons development, and emerging threats to withhold program funds already approved by Congress, or conditioning their release on contractor agreement to major and controversial new policy changes.

The letter, coordinated by the Aerospace Industries Association trade group, was initiated after Lockheed Martin Corp warned shareholders it might face liability unless the Pentagon quickly freed funds for costs already incurred on the $382 billion F-35 Joint Strike Fighter program.

Lockheed's concerns struck a chord with other companies, many of whom are suppliers on the F-35 program, or are seeing similar Pentagon efforts on their own programs.

The AIA letter also comes as defense companies brace for declines in defense spending after a decade of double-digit growth that will lead to program cancellations and slowdowns, as well as mounting pressures on profit margins.

U.S. defense officials say they are setting higher standards given smaller defense budgets, but insist they are not out to ruin defense company profits.

Lockheed Chief Executive Robert Stevens signed the AIA letter, along with executives from Boeing Co , Northrop Grumman Corp , Raytheon Co and a wide swathe of other companies in the sector.

After the letter was sent, Lockheed and the Pentagon this week reached a tentative agreement on their dispute over revamped contract terms for a fifth batch of F-35 fighter jets, but actual negotiations for the new planes have not yet begun.

REVIEW DEMANDED

In the letter, AIA members said the current model of financial risk-sharing between government and industry had resulted in development of world-class technology.

The department's proposed changes to this model will have significant competitive, financial, and employment implications (especially for small- and medium-sized suppliers) that we do not believe have been fully considered by the government or by the Congress, the executives said.

They urged Panetta to suspend implementation of the changes until a thorough review was done about the potentially far-reaching implications and risks of these actions.

Industry executives said they were concerned about a Pentagon drive to require industry to assume a far more significant share, if not preponderance, of the cost of design changes that arose on certain weapons programs like the F-35 that move into production while testing is still under way.

They said this so-called concurrency risk would cause significant disruption to and changed behavior from the defense industrial base, which is already bracing for layoffs and tighter profit margins as defense spending drops.

Weapons costs could rise because companies would price the increased risk into their contract bids, experienced contractors could opt not to compete for such programs, and overall innovation would be stifled, the executives said.

The letter also criticized Pentagon threats to withhold program funds for indefinite periods, and make payments contingent on companies agreeing to policy changes such as increased responsibility for design changes.

This is a questionable and troubling attempt to use the goodwill and extra financial risk that industry incurs to deliver systems on time and at lowest possible cost against us, it said. Companies often pay suppliers on their own dime to cover temporary delays in the federal budget process.

Pentagon threats to hold up funding imposed additional financial risk on publicly traded companies, and will require a total reevaluation of our ability to continue performance, at times when government funds are held up, they added.

The Pentagon's director of pricing, Shay Assad, and other top defense officials tried to reassure investors at a conference last week that they were not trying to cut profits.

Assad dismissed concerns raised by Lockheed and other companies, saying there was no overall shift in Pentagon policy and that contracts were negotiated on a case-by-case basis.

We don't want situations where we're asking companies to take an unreasonable risk, Assad told a conference hosted by Credit Suisse and Aviation Week.

The idea that there is a new policy going on here, it's just not true, he said. But he said the Pentagon was setting higher standards for its acquisition officials given the changing budget climate, and expected industry to do the same.

(Editing by Muralikumar Anantharaman)