The memorandum orders Peter Orszag, the White House budget director, to work with White House and agency officials to draft new contracting rules by the end of September.
Obama said defence budget overruns were particularly severe in Iraq - where around 150,000 private contractors are working for the US military - saying too much money had been paid out "for services that were never performed, buildings that were never completed, companies that skimmed off the top".
Several private contracting firms in Iraq, in particular Halliburton, once run by Dick Cheney, the former vice-president, and Blackwater, now known as Xe, have come under close scrutiny.
Obama also decried the lack of oversight in contracts awarded to the defence industry, whose weapons projects have too often been hit by delays and cost overruns.
And he pledged to end "cost-plus" contracts - allowing companies to charge the government costs plus a fixed profit no matter how poor their performance – which have been criticised as being open to abuse.
From 2000 to 2007, auditors who examined major US weapons contracts found that cost overruns added up to $295bn - a 700 per cent increase during the administration of George Bush, Obama's predecessor - while delays rose from 16 months to 21 months.
Last month Obama also ordered a review of large cost overruns on a new fleet of presidential helicopters, which raised concerns about how many military projects end up over budget.