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Using both qualitative and quantitative approaches, this article investigates the under-researched demand-side of locally-financed Payments for Environmental Services (PES). It assesses downstream users'' willingness to pay (WTP) for improved tap water quality in a setting where upstream landowners are clearing watersheds. The research findings are indicative of a considerable WTP for improved drinking water services and a definite local awareness of upstream–downstream interdependencies, suggesting potential for successful PES. Contingent Valuation (CV), however, found a substantially lower WTP under a PES scenario than under an alternative scenario involving infrastructure investments. The qualitative research angle indicates that the feasibility of a locally-financed PES system may have been negatively affected by the prevailing discursive framing of agricultural externalities and entitlements, raising issues about the fairness of such payments. Moreover, low levels of mutual trust were found to undermine the credibility of the PES framework. These results confirm that institutional failures contribute to environmental degradation and that PES should not be viewed as a market panacea transcending the local institutional context, but rather as a potentially complementary instrument within a broader rearrangement of environmental governance. [Copyright &y& Elsevier]