Finance and Economics Discussion Series (FEDS)
September 2019
The Welfare Costs of Misaligned Incentives: Energy Inefficiency and the Principal-Agent Problem
Abstract:
In many settings, misaligned incentives and inadequate monitoring lead employees to take self-interested actions contrary to their employer's wishes, giving rise to the classic principal-agent problem. In this paper, I identify and quantify the costs of misaligned incentives in the context of an energy efficiency appliance replacement program. I show that contractors (agents) hired by the electric utility (the principal) increase their compensation by intentionally misreporting program data to deliberately authorize replacement of non-qualified refrigerators. I provide empirical estimates of the impacts of misaligned incentives on (1) the effectiveness of energy efficiency retrofits and (2) welfare. I estimate that unqualified replacements reduce welfare by an average of $106 and save only half as much electricity as replacements that follow program guidelines. The same program without a principal-agent distortion would increase welfare by $60 per replacement. The resul ts provide novel evidence of how principal-agent distortions in the implementation of a potentially beneficial program can undermine its value.
Accessible materials (.zip)
Keywords: Energy efficiency, Firm behavior, Principal-agent problem
DOI: https://doi.org/10.17016/FEDS.2019.071
PDF: Full Paper