As the pioneer of China’s innovation-driven development, state-owned enterprises have been given more responsibilities and missions. However, scholars cannot tell whether state-owned enterprises can undertake such an essential task or not. The root cause lies in the agency problem caused by “owners’ absence” in state-owned enterprises and soft budget constraint problems accompanying state-owned property rights. Therefore, privatization was once considered a practical path for the reform of state-owned enterprises. Some previous studies show that state-owned enterprises’ operating efficiency can be significantly improved after privatization. Subsequently, more and more researches find that the potential costs or losses brought about by the privatization reform path may be huge. The performance is that after the privatization of state-owned enterprises, their innovation level has not been significantly improved, but has accelerated the loss of state-owned assets. Since then, scholars’ discussions on the innovation activities of state-owned enterprises have gradually transitioned from the perspective of privatization to the premise of ensuring state-owned properties. What kind of supervision and incentive mechanism will be able to promote the innovation of state-owned enterprises?

In 2016, under the guidance of General Secretary Xi Jinping, Report on the Work of the Government emphasized sound incentive mechanisms and fault-tolerance and error-correction mechanisms, and state-owned enterprises have successively started to implement these mechanisms. This provides a good opportunity to examine whether and how the design of the incentive mechanisms of state-owned enterprises affects innovation. Using the staggered-DID model, the primary findings document that fault-tolerance and error-correction mechanisms can not only encourage state-owned enterprise executives to innovate through the risk-taking mechanism, but also relieve the agency problem of executives in the innovation process through the supervision and governance mechanism, thereby helping the improvement of the innovation level of state-owned enterprises. In addition, we also find that fault-tolerance and error-correction mechanisms can not only increase the number of the innovations of state-owned enterprises, but also improve the quality of their innovations, manifested in a significant increase in invention patents and utility model patents.

This research has the following policy implications: Innovation is the key to tapping the new potential of China’s economic growth. The establishment of fault-tolerance and error-correction mechanisms in state-owned enterprises should be accelerated to promote the technological innovation and the transformation and upgrading of state-owned enterprises, thereby contributing to the high-quality development of the national economy. In order to maximize the innovation incentive effect produced by the fault-tolerance and error-correction mechanisms of state-owned enterprises, more effective equity incentives and promotion incentives should also be supplemented.