How does government policy lead SMEs to engage in innovation —Empirical Evidence from China

Within the past few years, Chinese small and medium-sized enterprises (SMEs) had exhibited remarkable innovation. These enterprises had leveraged cutting-edge technologies and creative strategies to achieve growth and success in the competitive global market. From advancements in AI and machine learning to breakthroughs in e-commerce and digital marketing, Chinese SMEs had shown a readiness to embrace innovation. The government had supported these efforts through financial subsidies and guiding policies. This study examines how financial subsidies and digital transformation, both backed by the government, impact innovation performance in SMEs, exploring the mechanism of these factors on enterprise innovation. In accordance with 1131 A-share listed SMEs in China between 2017 and 2022, in order to test theoretical hypotheses, this study utilizes multiple regression methods. The findings indicate that (1) Research and development (R&D) expenditure is positively linked to innovation performance in SMEs. R&D expenditure directly stimulates innovation activities. Even after running the instrumental variable method's robustness test, the outcome remains unchanged. (2) Financial subsidy can promote R&D expenditure in SMEs. By assisting SMEs in overcoming financial constraints and mitigating R&D risks, these subsidies function as a cost-sharing mechanism between the government and the enterprises. (3) The R&D expenditure significantly enhanced SMEs' innovation performance by increasing financial subsidies. And a clear crowding-in-effect is caused by the government subsidies on SME innovation for enhancing investor confidence, alleviating financing constraints, and strengthening market competitiveness. (4) Digital transformation did not directly impact the innovation performance of SMEs. It alone does not ensure successful innovation. Instead, it functioned primarily as an auxiliary mediator. The significance of digital transformation should not be overstated. This paper shed lights on the significance of finance subsidy and digital transformation in enhancing innovation within SMEs and offers valuable guidance for fostering enterprise innovation.