How Can Local Policy Uncertainty Encourage Firm Innovation: A Competitive Advantage Channel*

Exploring the turnover of city heads in China, I find that state‐owned enterprises (SOEs), which possess competitive advantages (especially resource‐based) due to innate government connections, significantly increase innovation compared with non‐SOEs when local policy uncertainty heightens. In particular, when the turnover of city heads occurs, SOEs are able to obtain a larger amount of external financing at lower costs than non‐SOEs. Additionally, SOEs that file invention patents at the height of local policy uncertainty have better product market performances. My findings indicate that heightened local policy uncertainty enables firms with innate government connections to explore first‐mover advantages through innovation activities.