Blonz, Joshua “The Welfare Costs of Misaligned Incentives: Energy Inefficiency and the Principal-Agent Problem” (Revised March 2021) | WP-297R

In many settings, misaligned incentives and inadequate monitoring lead employees to take self-interested actions. This paper identifies and quantifies the costs of this principal-agent problem 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 authorize replacement of non-qualified refrigerators. 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.