Adverse selection in water infrastructure PPP projects: A signaling game approach incorporating initial trust

Information asymmetry in public-private partnership (PPP) procurement may induce low-capability private-sector partners to disguise themselves as high-capability bidders, thereby generating adverse selection and reducing procurement efficiency. This problem is particularly significant in water infrastructure PPP projects because such projects usually involve high public welfare attributes, large sunk investments, long concession periods, and stringent requirements for construction, financing, operation, and maintenance capabilities. To examine the mechanism through which adverse selection emerges, this study develops a signaling game model between the government and private-sector partners by incorporating initial trust into the payoff structure. Specifically, the model distinguishes between the government’s initial trust in private-sector partners and private-sector partners’ initial trust in the government. In response to the need for computational validation, this revised version adds numerical simulations that map equilibrium regions, conduct one-way sensitivity analysis for p0, q0, F, Cs, and L, and report Monte Carlo results. The equilibrium analysis and simulations jointly show that a separating perfect Bayesian equilibrium can prevent adverse selection only when three conditions are satisfied: the government obtains a positive payoff from accepting high-capability partners, high-capability partners receive sufficient participation payoffs, and low-capability partners have no incentive to disguise themselves. The numerical results further indicate that excessive government initial trust and insufficient disguise costs expand pooling or semi-separating regions, whereas stronger verification costs, reputational penalties, and loss exposure reduce adverse-selection risk. Therefore, effective PPP procurement requires not unconditional trust but a trust-but-verified governance mechanism. Policy implications include strengthening qualification screening, improving credit information disclosure, increasing the cost of disguise, implementing reputational penalties, and enhancing the credibility of government commitments.