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

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 the replacement of nonqualified refrigerators. I estimate that each unqualified replacement reduces program benefits by $106 and saves 30 percent less electricity than replacements that follow program guidelines. The same program without a principal-agent distortion would increase program benefits by $60 per replacement. (JEL D82, L68, L94, L98)