Policy Certainty and Heterogeneous Firm Innovation: Evidence from a Developing Country

Abstract

This paper investigates how policy certainty affects firm innovation activities.The identification hinges on the overlap of the elite dualism system in China. Naturally, a city Party leader served as the prior mayor in the same city is more likely to carry out the policy decisions made by the previous local administration, since he/she is one of the crucial leaders to make these decisions. In this circumstance, the policy certainty level would be higher for local listed firms. We find that the patent filings of listed firms, who enjoy a more stable local policy environment, significantly and substantially increase into the future. Such positive effects are robust to different model specifications and subsample analyses. Moreover, this paper documents the role of heterogeneity in the effects of policy certainty on firm innovation. The increased patent filings caused by a higher level of local policy certainty are mostly driven by state-owned enterprises (SOEs), firms with no political connections, having lower financial constraints and smaller sizes. We further show that a higher level of local policy certainty would increase the stability of the amount of government subsidies for these firms, so they can more aggressively engage in innovation activities.