Working Paper

The Welfare Costs of Misaligned Incentives: Energy Inefficiency and the Principal-Agent Problem

Nov 29, 2018 | Joshua Blonz

Summary

I measure the welfare costs of the principal-agent problem in the context of an energy efficiency appliance upgrade program. I find that the principal-agent problem turns an otherwise welfare-increasing program into a welfare-reducing program.

Key Findings

  • The study uses variation in program rules to identify contractors intentionally misreporting program data to increase their compensation.
  • About half of the refrigerator replacements conducted in the program did not qualify based on program rules. Each unqualified replacement reduced welfare by $106. In contrast, qualified replacements increase welfare by $60.
  • The study provides the first empirical evidence for a cause of the non-performance of energy efficiency programs: the principal-agent problem.
  • These results apply to other energy efficiency programs because the incentives of contractors can undermine potential savings.

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-qualifi ed refrigerators. I provide empirical estimates of the impacts of misaligned incentives on (1) the effectiveness of energy efficiency retro fits and (2) social welfare. I estimate that unqualifi ed 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 results provide novel evidence of how principal-agent distortions in the implementation of a potentially bene ficial program can undermine its value.