14 January 2014While preserving water quality by contracting with farmers has been examined previously, we analyze these arrangements from a different perspective. This study uses a transaction cost framework, in conjunction with detailed case studies of two water quality payment schemes, to examine factors that increase and decrease transaction costs in order to improve policy choice as well as policy design and implementation. In both the Munich and New York City cases, agreements with farmers to change land management practices resolved the water quality problems. In Munich, factors including lack of rural/urban antipathy, homogeneous land use, utilization of well-developed organic standards, and strong demand for organic products decreased transaction costs. Using existing organic institutions addressed a range of environmental issues simultaneously. Factors that decreased transaction costs in both cases included: highly sensitive land was purchased outright and the existence of one large “buyer”. Adequate lead time and flexibility of water quality regulations allowed negotiation and development of the watershed programs. Tourism and eco-labels allow urban residents to become aware of the agricultural production practices that affect their water supply. We conclude with recommendations based on the experiences of these cities, both of which have been proposed as models for other schemes.