It is urgent to upgrade, replace and improve water supply facilities in China. Penalty, subsidy and water price increase are often considered the main policy tools for encouraging water supply companies to upgrade their production facilities. However, the implementation of upgrading water supply facilities is being confronted with some uncertainties because of the conflicts of involved stakeholders. This study develops a game model between municipal government and a water company to analyze their conflicts of interests and optimize the strategy for upgrading water supply facilities. Empirical analyses from three Chinese urban water companies are presented. Using theoretical and numerical analysis, the effects of penalty, subsidy and water price increase on strategies of upgrading water supply facilities were obtained. The main findings are that water price and penalty are the effective policies to optimize key stakeholders' strategies, while subsidy policy is not useful. The conclusion has important policy implications for ensuring water supply safety and reliability.

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