Effect of free trade area policy on innovation capability in the service industry

Dong, Qi; Bilan, Yuriy Article Effect of free trade area policy on innovation capability in the service industry Amfiteatru Economic Journal Provided in Cooperation with: The Bucharest University of Economic Studies Suggested Citation: Dong, Qi; Bilan, Yuriy (2024) : Effect of free trade area policy on innovation capability in the service industry, Amfiteatru Economic Journal, ISSN 2247-9104, The Bucharest University of Economic Studies, Bucharest, Vol. 26, Iss. 66, pp. 589-611, https://doi.org/10.24818/EA/2024/66/589 This Version is available at: https://hdl.handle.net/10419/300611 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may be saved and copied for your personal and scholarly purposes. You are not to copy documents for public or commercial purposes, to exhibit the documents publicly, to make them publicly available on the internet, or to distribute or otherwise use the documents in public. If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by/4.0/ Economic Interferences AE Vol. 26 • No. 66 • May 2024 589 EFFECT OF FREE TRADE AREA POLICY ON INNOVATION CAPABILITY IN THE SERVICE INDUSTRY Qi Dong1 and Yuriy Bilan2 1)Yangtze University, Jingzhou, China 2)Vytautas Magnus University, Kaunas, Lithuania Please cite this article as: Dong, Q. and Bilan, Y., 2024. Effect of Free Trade Area Policy on Innovation Capability in the Service Industry. Amfiteatru Economic, 26(66), pp. 589-611. DOI: https://doi.org/10.24818/EA/2024/66/589 Article History Received: 29 August 2023 Revised: 23 February 2024 Accepted: 28 March 2024 Abstract China has gradually established pilot free trade zones and implemented certain specific policies for its enterprises to deepen the economic system reform and expand the degree of market opening to the outside world. The establishment of a Free Trade Area exerts spillover effects and positive influences on import and export trade, synergistic regional development, and the ability to innovate of enterprises. However, in terms of policy, its role in enterprise innovation has not been explored. To explore the influence path of Free Trade Area Policy on the innovation ability of service industry companies, using the data of A-share listed companies in Shanghai and Shenzhen in the Guangdong Free Trade Area region from 2010 to 2021 and the Regression Discontinuity model, the micro mechanisms (intellectual property protection, equity incentives, and government subsidies) of the impact of the Free Trade Area Policy on the innovation capability of service industry companies were analysed. The results show that: (1) Intellectual property rights (IPR) protection and the innovation ability of service industry companies exhibit a U-shaped relationship. With the increase in IPR protection, the innovation ability of service industry companies first decreases and then increases. (2) Expanded equity incentive level internal gap increases the research and development (R&D) expenditures, but reduces the innovation capacity of service industry companies. (3) Government subsidies convey signals of innovation recognition to the market, reduce the business risks of service industry companies, and encourage improvements in innovation capability. The conclusions provide a theoretical basis and multi-dimensional ideas for service industry companies to improve their innovation capability. In addition, an empirical basis and reference is provided for the government administration of the Free Trade  Corresponding author, Qi Dong – e-mail: [email protected] This is an Open Access article distributed under the terms of the Creative Commons Attribution License, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. © 2024 The Author(s). AE Effect of Free Trade Area Policy on Innovation Capability in the Service Industry 590 Amfiteatru Economic Area to evaluate the effectiveness of policy implementation, optimise the policy structure, improve the policy system, and promote Free Trade Area Policy. Keywords: Free Trade Area Policy, service industry companies, enterprise innovation capability, Regression Discontinuity JEL Classification: M21, D21, H71 Introduction The construction of a Free Trade Area is China’s initiative to adapt to the background of trade globalisation. Implementing a proactive “Bringing-in and going-out strategy”, which deepens the internal institutional reform of a major initiative, is an important step not only in China’s economic transformation and trade structure improvement, but also in promoting investment liberalisation and facilitation, to adapt to the trend of economic globalisation objective requirements. From the establishment of the Shanghai Free Trade Area in September 2013 to September 2020, China has formed “1 (Shanghai) + 3 (Guangdong, Tianjin, Fujian) + 7 (Liaoning, Zhejiang, Henan, Hubei, Chongqing, Sichuan, Shanxi) + 1 (Hainan) + 6 (Shandong, Jiangsu, Guangxi, Hebei, Yunnan, Heilongjiang) + 3 (Beijing, Hunan, Anhui)” 21 provinces and 69 zones of Free Trade Areas in a geese formation. From the coast to the inland, from the northeast to the southwest, these Free Trade Areas are located in various important economic regions of China, basically covering the major economic sectors. Thus, a new pattern of all-round and high-level regional opening up with “no gap along the coast, focus on the mainland, and full growth” is coordinated with the east and west, land and sea to serve different economic zones. During the development of the Free Trade Area, the adoption of better policies can minimise more market entry barriers, streamline the negative list, promote trade liberalisation and facilitation, attract more investments, and enhance international trade exchanges. Thus, strengthening institutional innovation, exploring new paths and methods to dovetail high-standard rules, piloting dovetailing with international high-standard economic and trade rules, and promoting high-level system-based opening have become the core elements of Free Trade Area construction. The service industry is an important part of China’s all-around opening to the outside world. However, China’s overall foreign trade pattern shows a deficit, caused by trade in services that remains a weak point. While China’s trade in goods can usually reach tens of trillions of dollars, the trade in services is usually only a few trillion. Services import and export account for less than 20% of China’s total import and export, and the gap is relatively obvious compared with developed countries in the world. In 2022, China Beijing International Fair for Trade in Services, China announced its commitment to bridge the “digital gap” and promote the digitalisation of trade in services in line with the development trend of digitalisation, networking and intelligence. China intends to expand its special service export base and develop new business models and modes of services trade. In this regard, investigating the effect of the implementation of China's Free Trade Area Policy on the development of service industry companies presents considerable significance. Comprehensive research has been carried out on the effects of Free Trade Area Policy and enterprise innovation capability. The establishment of a Free Trade Area has effectively Economic Interferences AE Vol. 26 • No. 66 • May 2024 591 activated market players and promoted the free flow of capital, materials, talents, and other resources in and around the region, thereby significantly increasing the rate of economic growth (Wang and Liu, 2017; Liu and Wang, 2018; Li and Li, 2019). Several scholars also believe that the establishment of a Free Trade Area has an insignificant driving effect on regional economic development, the policy effect is not fully released, and the promotion effect is lagging (Song et al., 2019). The establishment of a Free Trade Area considers its type and number. Free Trade Areas may strive to reduce trade barriers, lower the threshold of market access, or promote trade freedom and facilitation (Ye, 2018). The internal factors influencing enterprise innovation capability include organisational level, corporate governance, managerial perception, and employee motivation, whereas the external factors include innovation network, resource integration, and strategic orientation. For example, increasing firm age and size can derive organisational inertia, and structured practices can bind the ability to self-adjust in co-evolution with the environment (Harman and Freeman, 1984). Equality incentive mitigates agency costs, aligns managerial and shareholder interests, and a catalytic effect on firm innovation (Tian and Meng, 2018; Zhao and Lin, 2019). Corporate innovation is driven by a combination of internal and external drivers, where internal firms need to absorb knowledge and external firms need to imitate and learn new knowledge (Albort-Morant et al., 2018). The degree of heterogeneity in enterprise innovation capability promotes its dynamic effects with firm performance (Schilke, 2014). Firms with institutional support tend to develop better (Back et al., 2014). Strengthening legal protection and policies can promote corporate innovation, such as those for intellectual property rights (IPR), which include tangible or intangible firm assets. Government support can also promote firms’ R&D investment and improve their innovation performance (Chen and Zhou, 2021). In summary, most of the studies on Free Trade Area Policy have been carried out from the macro-supply perspective, including its effects, while less attention has been paid to the micro aspects of enterprises from the policy demand perspective. Enterprises are both policy demanders and beneficiaries, and empirical evidence based on the micro-perspective can provide ideas for policy structure optimisation and improvement enrichment. Thus, this study further considers the following questions: What are the policies related to enterprise innovation capability in the Free Trade Area Policy system, given that policy support has a significant impact on the enhancement of enterprise innovation capability? What are the paths through which these policies act on the enterprise innovation capability? How does the Free Trade Area Policy affect service industry companies, which are unique in their assessment of innovation capabilities? To answer the above questions, we used data of Shanghai and Shenzhen A-share listed service industry companies in the Guangdong Free Trade Area of China from 2010 to 2021 as the research sample. This study examines the impact mechanism of policies such as intellectual property protection, equity incentive, and government subsidy on enterprise innovation capability in the Free Trade Area Policy system. The different effects of each policy are also analysed, including the increase of intellectual property protection, widening gap of equity incentive level, and signalling government subsidies on enterprise innovation capability. Furthermore, new utility and appearance patents at different levels of patent applications are subdivided and the degree of promotion of Free Trade Area Policy on different types of patent applications by sample is analysed. In comparison with existing studies, this study has more evident marginal contributions. First, we integrate the property rights system, total compensation, and signalling theories to build a research framework and enrich the theory of corporate innovation. Second, the structure of Free Trade Area Policy is divided into three aspects: intellectual property protection, equity AE Effect of Free Trade Area Policy on Innovation Capability in the Service Industry 592 Amfiteatru Economic incentive, and government subsidies, which provide new ideas for understanding the Free Trade Area Policy system and structure. Meanwhile, analysis of the mechanism of service industry companies' innovation ability through the Free Trade Area Policy system provides the theoretical basis and multi-dimensional ideas for service industry companies to improve their innovation ability. In addition, empirical basis and reference ideas are provided for Free Trade Area government management departments to evaluate the effectiveness of policy implementation, optimise policy structure, improve policy system, and promote the Free Trade Area Policy. The rest of this study is structured as follows: Section 1 is a literature review and presents the research hypothesis. Section 2 is the research design, which presents the data selection and variable descriptions, initial data processing, followed by the model setting and description. Section 3 is the analysis of the empirical results and robustness test, while Section 4 discusses the findings of this study. The last section is related to the conclusions. 1. Theoretical analysis and hypothesis development 1.1. Spillover mechanism of intellectual property protection A relatively weak intellectual property protection facilitates innovation. Imitating external knowledge allows companies to save on the innovation cost. That is, knowledge externalities reduce costs while technological imitation motivates firms to innovate (Antonelli and Colombelli, 2017). Companies with weak intellectual property protection are prone to “free riders.” When firms gather in environments where intellectual property protection is weak, they “carpool” with other corporate innovations (Bental and Fixler, 1988). By comparison, a strong intellectual property protection reduces the degree of market competition and even creates monopolies, thereby reducing knowledge and technology spillovers while enhancing investments in innovation (Li, 2020). The reason is that when the innovator is imitated, their profit weakens, and thus they increase their investment. This scenario also creates a game, where market competitiveness is instead enhanced in the case of weak intellectual property protection. Strengthening intellectual property protection, reducing external spillovers of knowledge, and generating excessive monopoly power may inhibit further innovation market competition, which in turn reduces corporate innovation performance. Strong intellectual property protection promotes innovation in four main paths: First, the level of intellectual property protection affects the intensity of firms’ R&D investment; that is, when the level of protection is low, firms cut back on R&D investment, and, conversely, a strong intellectual property protection promotes firms R&D investments, which in turn promotes innovation (Bosworth and Rogers, 2001). Innovators utilise intellectual property protection mechanisms to obtain appropriate returns from their investments by gaining funds, and intellectual property is an important mechanism to protect this firm asset (Aloini et al., 2017; Shavell and Van, 2001). Strengthening intellectual property protection thus stimulates innovation by ensuring a return on firms’ R&D investments (Siege and Wright, 2007). Second, IPR promotes innovation by protecting the inventor’s exclusive rights, the firm’s monopoly position, and market profits. An environment of low levels of intellectual property protection can create barriers to innovation by allowing imitators to quickly enter the market, and thus counterfeits can erode the profit margins of innovators (Zhao, 2006). Third, intellectual property protection reduces information asymmetry and promotes innovation. For companies, R&D is a necessary path to profitability and growth and is characterised by Economic Interferences AE Vol. 26 • No. 66 • May 2024 593 high and long-term risks. Innovation activities contribute to information uncertainty about the future value of a firm’s assets, and highly protected intellectual property reduces information ambiguity and asymmetry within and outside the firm, which thereby increases in market value (Huang et al., 2020). Fourth, intellectual property protection can facilitate the growth of startups and provide innovators with the opportunity to establish a base in the industry (Graham and Sichelman, 2016). In conclusion, when intellectual property protection is weak, firms benefit more from knowledge and technology spillovers. The market competition increases as similar products appear to flood the market. Innovators invest more in innovation for fear of being overtaken by imitators, thus reducing their own profits (Jeng and Pak, 2016). As intellectual property protection increases, corporate innovation efforts may decrease. With the further increase in intellectual property protection, intellectual property protection promotes corporate innovation investment, protects investment monopoly rents and profits, and reduces information asymmetry. This scenario frees up time for companies to establish their industry base and again stimulates their independent innovation drive. Based on the above analysis, the following hypothesis was proposed. Hypothesis 1: intellectual property protection and service industry companies’ innovation ability show a U-shaped relationship. As the strength of intellectual property protection increases, service industry companies’ innovation ability first decreases and then increases. 1.2. Internal compensation mechanism of equity incentive The long-term and risky nature of corporate innovation involves motivating employees to work hard and to commit to relevant long-term company activities. An equity incentive is a compensation contract that grants relatively appropriate equity to core employees, giving them the power to distribute the residual earnings of the company and effectively enhancing the sense of equality and narrowing their income gap with executives (Zhang et al., 2020). Unlike equity incentives, where monetary compensation reflects hierarchical and position gaps, incentive earnings rely on the future prices of the underlying stock and the number of equity grants. In addition, executives and employees are aligned in terms of equity incentives (Banker et al., 2011). Employees can only be rewarded with equity incentives by working hard and improving the long-term performance of the enterprise. This long-term incentive tool reflects the fairness of an improved compensation structure. The targets of equity incentives are divided into executives and non-executives that are mainly considered as core employees. If these core employees do not receive the same reward for the same effort, then the level of equity incentive shows a large internal gap. In this case, the core employees can suffer from psychological shock and have a negative effect on corporate innovation (Pan et al., 2020). Executives have decision-making authority over resource allocation in the firm and are incentivised to increase R&D expenditures to achieve high returns, although the ability of R&D expenditures to generate innovative outputs and returns depends on the core employees (Yin et al., 2021). Hence, the executives in the firm dominate the input aspect of innovation, while the core employees dominate the output aspect. The core employees are the real performers and participants in innovation tasks, mastering the core business of the company, and exerting their expertise. These core employees comprise the most important driving force in increasing the firm value (Vuksanović et al., 2022). Therefore, when equity incentives have large internal gaps, core employees may feel that they are not being rewarded for their efforts. The effect of equity incentives weakens, AE Effect of Free Trade Area Policy on Innovation Capability in the Service Industry 594 Amfiteatru Economic thus reducing the motivation to innovate (Xu et al., 2019). On this basis, the following hypothesis was proposed. Hypothesis 2: Expanding the internal gap in the equity incentives of the service industry companies can increase their R&D expenditures but reduces their innovation capability. 1.3. Risk aversion mechanism for government grants Gillingham and Sweeney’s (2010) theory of market failure states that the social benefits of a firm’s R&D activities can be much greater than the benefits of R&D due to its spillover effects. This trend is exacerbated if the firm has a good public image. However, R&D activities are usually characterised by long, irreversible, and risky cycles, which inhibit the impulse and idea of corporate innovation. In this case, if the government can provide a certain amount of financial support, such as subsidies, then a new impetus may be gained for corporate innovation. Therefore, government subsidies are an important means of regulating market failures (Winston, 2007). Based on the resource-based view, the inflow of government resources can compensate for the shortage of firms' own innovation resources, and government subsidies can also provide firms with relief from their financial constraints and allow them to relax through cash flow (Mani, 2002). Based on signaling theory, a government that provides large-scale subsidies and support to an industry sends a signal to the outside world; that is, such industry is highly recognised by the government and is the future direction of development, which brings a capital inflow from financial institutions and investment enterprises and balances the information asymmetry between enterprises and investors (Yang et al., 2019). On this basis, the following hypothesis was proposed. Hypothesis 3: Government subsidies send innovation recognition signals to the market, reduce the business risks of service industry companies, and promote innovation capability. 2. Methodology 2.1. Regression model selection Considering the advantages and disadvantages of the Regression Discontinuity model, and referring to Lee and Lemieux (2010), we present the following construct: ibaii k k k ki WBAWDDexexy    ln)()( (1) where i y denotes the number of patent applications or patents granted by service industry companies, which is logarithmically normalised. The indicators of enterprise innovation capability naturally exhibit a left-skewed distribution, and most of the companies’ observed values are clustered in 0–5 patents, for which the dependent variable is logarithmically normalised. The histogram, which can be presented later, shows that the left bias of the variables is greatly improved. In Eq. (1), x is the grouped variable, the value of the annual data from 2000–2021, which is x =1 for 2000 and x =22 for 2021. e represents the time when the Free Trade Area Policy was implemented. i D takes the value of 1 when ex but 0 when ex . In the regression equation, the parameter  , or Free Trade Area Policy on the innovation capacity of service industry companies, must be estimated and the result is the disposal effect. a W and b W indicate that the various control variables are added to the model in linear and logarithmic patterns, respectively. The Regression Discontinuity method is used Economic Interferences AE Vol. 26 • No. 66 • May 2024 595 to obtain consistent and unbiased estimates without using control variables when performing model testing. However, control variables are necessary in the robustness test for model optimisation. Considering the long time span of the data used, in addition to the Free Trade Area, exogenous shocks affect the innovation capacity of service industry companies. As such, the Regression Discontinuity for the relevant events must be estimated to meet the robustness requirements. 2.2. Data 2.2.1. Sample data selection The enterprise data were obtained from the WIND, CSMAR, State Intellectual Property Office, and China National Institutes databases. A-share listed companies in Shanghai and Shenzhen in the Guangdong Free Trade Area region were used as the sample. In the selection of the study period, 2010 is chosen as the starting observation year and the data from 2010– 2021 are used as the sample for regression analysis. Within this time interval, the innovation level and internationalisation of Chinese Free Trade Area enterprises are in a relatively stable growth trend, which provides a suitable observation window and period for the study. In terms of other factors affecting the innovation capability of service enterprises, their input is also largely affected by relevant major events, such as the regional policy restrictions on foreign investment and the outbreak of the new Coronavirus disease in 2020. During the empirical regression analysis, trade-offs need to be made with respect to the external environment of the firm and the data availability. The selection of enterprises includes the following criteria: non-consecutive loss-making in the past five years; non-ST enterprises listed for three years or more; companies with incomplete variables that cannot be completed and have been delisted are excluded; and those with too many missing values of key indicators. As such, the final sample comprises 12,353 observations from 856 listed companies. The data collection includes international operations, financial indicators, and corporate governance from companies in the CSMAR (China Stock Market & Accounting Research Database). The databases related to the innovation capacity of service industry companies are derived from the State Intellectual Property Office, and the missing values of patents are obtained by manual search of the database of the Chinese Institute of Science. The calculation and collation of the values are carried out by using Excel and Stata software. 2.2.2. Sample data range Free Trade Area listed industries include professional and technical services, Internet and related services, warehousing, accommodation, insurance, public facilities management, other financial services, agriculture, forestry, animal husbandry and fishery services, health, business services, radio, television, film and video recording production, real estate, education, culture and arts, education, industry, sports and entertainment goods manufacturing, news and publishing, water transportation, telecommunications, radio and television and satellite transmission services, science and technology promotion and application services, leasing, textiles, textiles, clothing, apparel, air transport, loading and unloading and transport agency, computer, communications and other electronic equipment, money financial services, capital market services, software and information technology services, road transport, postal services, railroad transportation, retail trade, and catering. AE Effect of Free Trade Area Policy on Innovation Capability in the Service Industry 596 Amfiteatru Economic 2.3 Variable definition and measurement The explanatory variables are the number of patent applications and of patents granted. In existing studies, the explanatory variables such as the innovativeness capability of a corporation typically use the company R&D expenses, the number of patent applications, the number of cited patent applications, the number of patents, and the number of cited patents. R&D is highly correlated with the company labour costs and the industry, and the input and output of innovation capabilities has a large gap. Possibly, the number of patent applications cited has not yet been noticed and identified by other companies given the short time of their availability. The number of patent applications is the result of enterprises’ subjective initiatives. On the one hand, to protect their innovation achievements, enterprises protect their rights and interests by applying for patents. On the other hand, compared to the granting of patents, patent applications reflect the timelier innovation activities and their initial innovation investment. The internal dynamics of corporate innovation are affected by the fact that patent applications are subject to review by different levels of regulatory and examination bodies. Furthermore, the nature of the patent is further examined. According to the classification of patent nature, patents are classified into two categories: utility and design innovation. These categories are used as the explanatory variables in further analysis, and the number of utility model patents better reflects the innovation ability of enterprises and brings them a stronger competitive advantage in the market. The core explanatory variables include intellectual property protection, equity incentive, and government subsidies. The intellectual property protection is measured using the number of intellectual property litigation cases. This paper measures the intensity of intellectual property protection by multiplying the enforcement intensity on the basis of a uniform GP index (Han and Li, 2005; Shi and Gu, 2013). The GP Index is an internationally accepted index of the strength of IPR legislation. China’s GP Index increased from 2.51 in 1984, when the Patent Law was established, to 4.52 in 2010. The GP Index has remained unchanged at 4.52 during the subsequent period of 2010-2017, as the Patent Law has not been revised. When measuring the intensity of IPR enforcement, we refer to the practice of existing studies and implement the measurement from four perspectives: the intensity of intellectual property enforcement, the level of judicial protection, intellectual property protection awareness, and the level of economic development. Among these four, the strength of intellectual property enforcement is measured by the cumulative case completion rate; the level of judicial protection is measured by the proportion of the number of lawyers to the total population of the country (10,000 people); the awareness of intellectual property protection is measured by the number of patent applications received divided by the total population of the country (10,000 people); and the level of economic development is measured by the growth rate of the gross domestic product (GDP). The above study assesses the strength of intellectual property protection from the macro level and the level of intellectual property protection of service industry companies from the micro level. Meanwhile, the number of intellectual property litigation cases reflects the current status of intellectual property protection for enterprises. The equity incentive adopts the internal gap of its levels as the measurement index. As stipulated in the “Management Measures of Equity Incentive for Listed Companies,” incentive targets can include directors, senior management, core technical personnel, or core Economic Interferences AE Vol. 26 • No. 66 • May 2024 603 considered. The regression results show that the inclusion of control variables or the choice of a 2nd-order expression still reflect the valid prediction of the model. 3.3. Further analysis The different levels of patent applications are further subdivided into new utility and design patents. A new utility patent refers to a new technical solution for the shape, construction, or combination thereof of a product that is suitable for practical use. In comparison to invention patents, utility patents are less inventive and innovative but can still be used as a way to measure the level of corporate innovation. Another type of patent application is for design, which, according to the Patent Law, refers to a new look that is aesthetically pleasing and suitable for industrial application based on the shape or pattern of a product or a combination thereof, as well as the combination of colour and shape or pattern. For utility and design patent applications, the same method of Regression Discontinuity is used for estimation. The results for utility patent applications are consistent with those for general patent applications; that is, the establishment of the Free Trade Area Policy has a positive effect on utility patent applications but shows no similar effect on design applications. (Table no. 6) Table no. 6. Coefficient results of Regression Discontinuity D for parameter estimation (new utility patent/design patent) New Utility Patent Design Patent X-e 288.55* (10.043) 212.64** (14.032) 317.36** (11.043) 258.94** (15.042) D*(X-e) 1923.42*** (19.071) 1524.56** (24.061) 1452.67* (17.051) 1242.98*** (26.041) INT2 0.251* (0.052) 0.198* (0.031) 0.299 (0.033) 0.211 (0.031) INC -0.361** (0.033) -0.311* (0.033) -0.288* (0.022) -0.300 (0.022) SUB 0.401* (0.038) 0.377* (0.043) 0.367 (0.033) 0.299 (0.012) GPR —— 42.121** (0.061) —— 30.177 (0.052) ROA —— -191.001* (0.070) —— -156.471* (0.061) ART —— 0.211* (0.052) —— 0.233 (0.062) TAT —— 0.301* (0.063) —— 0.255* (0.052) EPS —— 0.281* (0.069) —— 0.311 (0.029) PSC —— 0.190* (0.041) —— 0.188* (0.031) NAPS —— 0.204** (0.051) —— 0.155 (0.041) Year —— 0.013** (0.010) —— 0.020* (0.012) _2 R 0.811 0.601 0.741 0.599 F 299.911 166.633 211.111 199.658 Note: * indicates a 10% significance level, ** indicates a 5% significance level, and *** indicates a 1% significance level. Data in parentheses are standard deviations. AE Effect of Free Trade Area Policy on Innovation Capability in the Service Industry 604 Amfiteatru Economic 3.4. Robustness tests The first robustness test is non-parametric. For the time point e=5, the rd command of Stata 13 is applied for the non-parametric test, which requires the selection of different bandwidths and kernel functions for the Regression Discontinuity. According to the criterion, different bandwidths h are selected such that h = 0.5, 0.75, 1.25, 1.5. That is, the kernel functions are estimated for the optimal bandwidths of 1/2,3/4,3/4,3/2 of the size distribution. Based on the determination of the disposition effect, a similar conclusion is obtained by choosing different hyperparameters such that the point can be considered as an important jump. (Table no. 7) Table no. 7. Results of coefficients of Regression Discontinuity D for choosing different bandwidths Bandwidth size Triangular Core Core Matrix 0.5h 1824.991** (20.087) 1420.213*** (19.097) 0.75h 1882.320*** (23.078) 1939.131* (18.086) 1.25h 1570.923* (10.081) 1899.023*** (9.081) 1.5h 1223.403*** (12.066) 1287.145* (15.076) Note: * indicates a 10% significance level, ** indicates a 5% significance level, and *** indicates a 1% significance level. Moreover, to ensure the validity of the Regression Discontinuity, the continuity of each control variable at the breakpoint is examined in the robustness test. According to the rd command in Stata, each control variable is continuous at e=5. Table no. 8 shows the results, where the control variables maintain continuous continuity at the breakpoints, but none are observed at e=5. Table no. 8. Parameter estimates for control variables at e=5 B Std Sig GPR 0.139 0.041 0.580 ROA 0.020 0.012 0.893 ART -0.209 0.033 0.125 TAT 0.508 0.042 0.380 EPS 0.020 0.001 0.481 PSC 0.412 0.091 0.460 NAPS 0.302 0.240 0.542 Year 0.110 0.173 0.182 4. Discussion All the empirical results in this study support the proposed hypotheses. In the context of China's vigorous construction of free trade pilot zones, institutional innovation brings policy dividends, while intellectual property protection, equity incentives, and government subsidies have positive effects on the innovation output of service industry companies. The policy dividend is brought by the system innovation. Economic Interferences AE Vol. 26 • No. 66 • May 2024 605 First, Table no. 5 reports the regression results of the effect of intellectual property protection on enterprise innovation capability. The level term of intellectual property protection has a significant negative effect while its squared term has a significant positive effect on patent applications and grants, which verifies Hypothesis 1 that intellectual property protection has a U-shaped relationship with enterprise innovation capability. When intellectual property protection is weak, firms benefit more from knowledge and technology spillovers. Due to the emergence of competing products flooding the market, market competitiveness increases, and innovators invest more in R&D due to the fear of being overtaken by imitators and reducing their profits (Jeng and Pak, 2016). As intellectual property protection strengthens, corporate innovation efforts are likely to decline. However, the further increase of intellectual property protection promotes corporate innovation investment, protects investment monopoly rents and profits, reduces information asymmetry, frees up the industry base for firms to build, and again stimulates enterprises to innovate (Li, 2020). Second, Models 1-5 in table no. 5 report a significant negative effect of the intra-equity incentive level gap with enterprise innovation capability. As the level of equity incentives for executives becomes higher than that for core employees, the corporate R&D expenditure in the year after the implementation of the equity incentive also increases. However, the number of corporate patent applications in the one and two years after the implementation of the equity incentive decreases, supporting Hypothesis 2 that the increase in the internal gap in the level of equity incentives increases corporate R&D expenditure, but reduces corporate innovation output (Pan et al., 2020). Core employees are the real implementers and direct participants in innovation programs, and may feel unfairly rewarded when the level of equity incentive has a large internal gap. The role of equity incentive weakens, thereby reducing their motivation to innovate (Vuksanović et al., 2022). Third, government subsidies in Table no. 5 have a significant positive effect on both patent applications and grants, supporting Hypothesis 3. That is, government subsidies send innovation recognition signals to the market, reduce the business risk of service industry companies, promote innovation capability, and corporate innovation performance has a strong dependence on R&D funds. Government subsidies can thus stimulate the innovation enthusiasm of companies (Yang et al., 2019). Fourth, the coefficients of patent applications and grants are further analysed. For patent applications, the coefficient shows that the effect of Free Trade Area implementation is positively significant, and the number of patent applications by firms shows a clear jump at the end of 2015. However, for patent grants, the coefficient is insignificant, indicating that the policy effect of the Free Trade Area is not effective and may have a certain lag (Song and Guo, 2019). Fifth, the different levels of patent applications are further subdivided into new utility and design patents. The results for utility patent applications are consistent with those for general patent applications. That is, the establishment of the Free Trade Area Policy has a positive effect on utility patent applications (Albort-Morant et al., 2018), but shows no similar effect on design applications (Schilke, 2014). AE Effect of Free Trade Area Policy on Innovation Capability in the Service Industry 606 Amfiteatru Economic Conclusion and insights Main findings This study adopts secondary data of firm dimension, combined with panel data of service industry companies listed in Shanghai and Shenzhen A-shares in the Guangdong Free Trade Area. A parametric Regression Discontinuity model is used to analyse the mechanism of influence of policies such as Free Trade Area intellectual property protection, equity incentives, and government subsidies on the innovation capability of service industry companies. The main conclusions obtained in this study are as follows: First, intellectual property protection and the innovation capability of service industry companies show a Ushaped relationship; as the strength of intellectual property protection increases, the innovation capability of service industry companies first decreases and then increases. Second, expanding the gap within the level of equity incentives increases the R&D expenditures but reduces the innovation capacity of service industry companies. Third, government subsidies send innovation recognition signals to the market, reduce the business risks of service industry companies, and promote innovation capacity. Moreover, the Free Trade Area Policy affects the innovation of service industry companies in terms of their patent applications, with a significant increase before and after the policy implementation. Moreover, in different patent dimensions, the Free Trade Area Policy significantly affects the number of utility model patents, but shows no similar effect on the number of design patents. Management insights The findings imply the need for the following:  Strengthen intellectual property protection, further improve and revise intellectual property protection-related laws and regulations, and improve the applicability of legislation; improve the functions of intellectual property legislation, judicial, and administrative protection, and their articulation mechanisms; clearly define property rights, protect the intellectual property rights of Free Trade Area enterprises, and give full play to the incentive effect of property rights on enterprises; adopt new-age information technology to realise the effective connection of isolated information such as patents, trademarks, and trade to open up intellectual property information silos, and improve the efficiency of service industry companies in carrying out IPR transactions.  Promote equity incentive policy; accelerate the improvement of the performance allocation system that encourages innovation and creativity of talents; create a system that encourages the participation of intellectual property production factors such as knowledge, patents, technology, and management in the distribution to motivate talents to innovate; utilise the leverage of financial policies to improve the Free Trade Area “governmentoriented rewards, the main unit rewards, supplemental social rewards” talent reward system, the formation of talent selection criteria and rewards, and the distribution of innovation incentives for talent.  Optimise the structure of financial support; Establish a screening and selection mechanism for target enterprises with substantive innovation as the main focus and overall innovation as a supplement, then precisely support R&D funds to ease the pressure on Economic Interferences AE Vol. 26 • No. 66 • May 2024 607 enterprises and achieve high-quality innovation output; Perfect the tax policy system of the GSP to support corporate innovation and appropriately increase the tax incentives for regions with low marketization. The comprehensive use of “pre-support” and “post-subsidy” means optimising the combination of policy instruments.  At the corporate level, shares or equity interests are granted to incentive recipients in the form of a contract to promote their positive value from the perspective of property rights. Thus, the purpose of enhancing the firm value and improving the governance structure can be achieved, and thereby reflect the characteristics of Free Trade Area equity incentive. Research shortcomings and prospects This paper reveals the influence mechanism between the Free Trade Area Policy and the innovation capability of service industry companies, but several questions remain to be solved. First, the strong promotion of China’s Free Trade Area occurred in 2015, and the policy effect interval is relatively short, which may cause bias in the estimation results. Second, the selection of Guangdong, a representative region, as the sample for the empirical study is appropriate for the service industry, although corporate innovation in other industries is ignored. Third, the construction of the Free Trade Area itself has an enhancing effect on the output level of corporate innovation, perhaps not only limited to intellectual property protection, equity incentive, and government subsidies, but also to a strong relationship with the nature and size of enterprises. For example, the above effect differs between state-owned and non-state-owned. The lack of an analysis of property rights and enterprise size in this study may provide a direction for future research. References Albort-Morant, G., Leal-Rodríguez, A. L. and De Marchi, V., 2018. Absorptive capacity and relationship learning mechanisms as complementary drivers of green innovation performance. Journal of Knowledge Management, [e-journal] 7, pp. 3-10. https://doi.org/10.1108/JKM-07-2017-0310. Aloini, D., Lazzarotti, V., Manzini, R. and Pellegrini, L., 2017. IP, openness, and innovation performance: an empirical study. Management Decision, [e-journal] 55(6), pp. 1303-1327. http://doi.org/ 10.1108/MD-04-2016-0230. Antonelli, C. and Colombelli, A., 2017. The locus of knowledge externalities and the cost of knowledge. Regional Studies, [e-journal] 51(8), pp. 1151-1164. http://doi.org/10.1080/ 00343404.2017.1331294. Antonelli, C., 2018. Knowledge properties and economic policy: a new look. Science and Public Policy, [e-journal] 45(2), pp. 151-158. http://doi.org/10.1093/scipol/scx070. Banker, R. D., Huang, R.. and Natarajan, R., 2011. Equity incentives and long‐term value created by SG&A expenditure. Contemporary Accounting Research, [e-journal] 28(3), pp. 794-830. http://doi.org/10.1111/j.1911-3846.2011.01066.x. Bental, B. and Fixler, D., 1988. Firm behavior and the externalities of technological leadership. European Economic Review, [e-journal] 32(9), pp. 1731-1746. http://doi.org/10.1016/0014-2921(88)90082-7. AE Effect of Free Trade Area Policy on Innovation Capability in the Service Industry 608 Amfiteatru Economic Bosworth, D. and Rogers, M., 2001. Market value, R&D and intellectual property: an empirical analysis of large Australian firms. Economic Record, [e-journal] 77(239), pp. 323-337. http://doi.org/10.1111/1475-4932.t01-1-00026. Chauffour, J.P. and Maur, J.C., 2011. Preferential trade agreement policies for development: a handbook. World Bank Publications, [e-journal] 6, pp. 207-209. https://doi.org/10.1596/978-0-8213-8643-9. Chen, X.H. and Zhou, K., 2021. Innovation heterogeneity, government subsidies and the development of civil-military integration corporate innovation. Journal of Beijing University of Technology (Social Science Edition), [e-journal] 23(1), pp. 117-126. http://doi.org/10.15918/j.jbitss1009-3370.2021.3014. Eggers, J.P. and Kaplan, S., 2013. Cognition and capabilities: A multi-level perspective. Academy of Management Annals, [e-journal] 7(1), pp. 295-340. https://doi.org/10.1080/19416520.2013.769318. Gelman, A. and Imbens, G., 2019. Why high-order polynomials should not be used in regression discontinuity designs. Journal of Business & Economic Statistics, [e-journal] 37(3), pp. 447-456. http://doi.org/10.1080/07350015.2017.1366909. Gillingham, K. and Sweeney, J., 2010. Market failure and the structure of externalities. In: S.n, 2010. Harnessing Renewable Energy in Electric Power Systems: Theory, Practice, Policy. S.l.: S.n., pp. 87-109. Graham, S.J. and Sichelman, T.S., 2016. Intellectual property and technology startups: what entrepreneurs tell us. In Technological Innovation: Generating Economic Results. In: M.C. Thursby eds., 2016. Leeds: Emerald Group Publishing Limited, pp. 163-199. http://doi.org/10.1108/S1048-473620160000026006. Han, Y.X. and Li, H.Z., 2005. A quantitative analysis on the level of intellectual property protection in China. Scientific Research, [e-journal] 3, pp. 377-382. http://doi.org/10.16192/j.cnki.1003-2053.2005.03.017. Harman, M.T. and Freeman, J., 1977. The Population Ecology of Organizations, Structural Inertia and Organizational Change. American Sociological Review, 49, pp. 149-164. Helfat, C.E. and Peteraf, M.A., 2015. Managerial cognitive capabilities and the microfoundations of dynamic capabilities. Strategic Management Journal, [e-journal] 36(6), pp. 831-850. https://doi.org/10.1002/smj.2247. Huang, D., Duan, H. and Zhang, G., 2020. Analysis on the Enterprises’ Innovation Quality Based on the Patent Value: A Comparison between Public and Private Enterprises in China. Sustainability, [e-journal] 12(8), article no. 3107. http://doi.org/ 10.3390/su12083107. Im, H.J. and Shon, J., 2019. The effect of technological imitation on corporate innovation: Evidence from US patent data. Research Policy, [e-journal] 48(9). https://doi.org/10.1016/j.respol.2019.05.011. Jeng, D.J.F. and Pak, A., 2016. The variable effects of dynamic capability by firm size: the interaction of innovation and marketing capabilities in competitive industries. Economic Interferences AE Vol. 26 • No. 66 • May 2024 609 International Entrepreneurship and Management Journal, [e-journal] 12(1), pp. 115-130. http://doi.org/10.1007/s11365-014-0330-7. Kaklauskas, A., Banaitis, A., Ferreira, F.A., Ferreira, J.J., Amaratunga, D., Lepkova, N., Ubartė, I. and Banaitienė, N., 2018. An evaluation system for university–industry partnership sustainability: Enhancing options for entrepreneurial universities. Sustainability, [e-journal] 10(1), article no. 119. https://doi.org/10.3390/su10010119. Kashiha, M., Depken, C. And Thill, J.C., 2017. Border effects in a free-trade zone: Evidence from European wine shipments. Journal of Economic Geography, [e-journal] 17(2), pp. 411-433. https://doi.org/10.1093/jeg/lbw017. Lee, D.S. and Lemieux, T., 2010. Regression discontinuity designs in economics. Journal of Economic Literature, [e-journal] 48(2), pp. 281-355. http://doi.org/10.2307/20778728. Lewandowska, A., 2021. Interactions between investments in innovation and SME. Journal of International Studies, [e-journal] 14(1), pp. 285-307. http://doi.org/10.14254/20718330.2021/14-1/20. Liu, B.L. and Wang, Y., 2018. Study on the effect of Free Trade Area on regional innovation capacity: Evidence from a quasi-experiment in Shanghai Free Trade Pilot Zone. Economic and Management Research, [e-journal] 39(9), pp. 65-74. https://doi.org/10.13502/j.cnki.issn1000-7636.2018.09.006. Li, S.K. and Li, L.Y., 2019. Research on the policy effects of Free Trade Area on industrial structure upgrading: A quasi-natural experiment based on Shanghai Free Trade Pilot Zone. Economic Jingwei, [e-journal] 36(5), pp. 79-86. https://doi.org/10.15931/ j.cnki.1006-1096.20190624.007. Li, X.Y., 2020. Research on some innovation policies affecting the capability of enterprise innovation in China. University of International Business and Economics, [e-journal] http://doi.org/10.27015/d.cnki.gdwju.2020.000064. Lv, K.J. and Sun, H., 2020. The inner mechanism of government subsidies' impact on corporate innovation performance: A study based on new energy enterprises. Science and Technology Management Research, [e-journal] 40(6), pp. 54-62. http://doi.org/CNKI:SUN:KJGL.0.2020-06-008. Mani, S., 2002. Government, innovation and technology policy: an international comparative analysis. S.l.: Edward Elgar Publishing. Pan, X., Wan, X., Wang, H. and Li, Y., 2020. The correlation analysis between salary gap and enterprise innovation efficiency based on the entrepreneur psychology. Frontiers in Psychology, [e-journal] 11, article no. 1749. http://doi.org/10.3389/fpsyg.2020.01749. Pullen, J., 2021. Government infrastructure investment dividends and urban development. American Journal of Economics and Sociology, [e-journal] 80(2), pp. 721-745. http://doi.org/10.1111/ajes.12388. Sattayaraksa, T. and Boon-itt, S., 2017. The roles of CEO transformational leadership and organizational factors on product innovation performance. European Journal of Innovation Management, [e-journal] 21(2), pp. 227-249. https://doi.org/10.1108/EJIM06-2017-0077. AE Effect of Free Trade Area Policy on Innovation Capability in the Service Industry 610 Amfiteatru Economic Schilke, O., 2014. On the contingent value of dynamic capabilities for competitive advantage: The nonlinear moderating effect of environmental dynamism. Strategic Management Journal, [e-journal] 35(2), pp. 179-203. https://doi.org/10.1002/smj.2099. Shavell, S. and Van Ypersele, T., 2001. Rewards versus intellectual property rights. The Journal of Law and Economics, [e-journal] 44(2), pp. 525-547. http://doi.org/10.1086/322811. Shi, Y.P. and Gu, Q.L., 2013. Intellectual property protection, heterogeneous firms and innovation: Evidence from Chinese manufacturing industries. Financial Research, [ejournal] 8, pp. 136-149. http://doi.org/CNKI:SUN:JRYJ.0.2013-08-011. Siegel, D.S. and Wright, M., 2007. Intellectual property: the assessment. Oxford Review of Economic Policy, [e-journal] 23(4), pp. 529-540. http://doi.org/10.15405/ epsbs.2018.12.159. Soltani, H., Triki, M.B., Ghandri, M. and Abderzag, F.T., 2021. Does geopolitical risk and financial development matter for economic growth in MENA countries. Journal of International Studies, [e-journal] 14(1), pp. 103-116. http://doi.org/10.14254/20718330.2021/14-1/7. Song, L.Y. and Guo, M., 2019. Research on the impact of Free Trade Area Policy on local financial resources: an analysis based on double difference method and synthetic control method. Exploration of Economic Issues, [e-journal] 11, pp. 14-24. https://doi.org/CNKI:SUN:JJWS.0.2019-11-003. Tian, X. and Meng, Q.Y., 2018. Can equity incentive programs promote corporate innovation. Nankai Management Review, [e-journal] 21(3), pp. 176-190. https://doi.org/10.3969/j.issn.1008-3448.2018.03.017. Vuksanović Herceg, I., Kuč, V., Mijušković, V.M. and Herceg, T., 2020. Challenges and driving forces for industry 4.0 implementation. Sustainability, [e-journal] 12(10), article no. 4208. http://doi.org/10.3390/su12104208. Wang, L.H. and Liu, Z.H., 2017. Study on the impact effect of Shanghai Free Trade Area on regional economy: Based on the perspective of “counterfactual” thinking. International Trade Issues, [e-journal] 2, pp. 3-15. https://doi.org/10.13510/j.cnki.jit.2017.02.001. Winston, C., 2007. Government failure versus market failure: Microeconomics policy research and government performance. S.l.: Brookings Institution Press. Xie, Q., Xue, X.L. and Fu, M.W., 2019. A review of research on the application of Regression Discontinuity design method. Economic Management, [e-journal] 35(2), pp. 69-79. http://doi.org/10.13962/j.cnki.37-1486/f.2019.02.006. Xu, X.L., Chen, H.H., Li, Y. and Chen, Q.X., 2019. The role of equity balance and executive stock ownership in the innovation efficiency of renewable energy enterprises. Journal of Renewable and Sustainable Energy, [e-journal] 11, article no. 055901. http://doi.org/10.1063/1.5116849. Yang, B. and Li, B., 2021. “One belt, one road” initiative and corporate innovation upgrading. Research Management, [e-journal] 42(1), pp. 47-56. https://doi.org/10.19571/j.cnki.1000-2995.2021.01.005. Economic Interferences AE Vol. 26 • No. 66 • May 2024 611 Yang, X., He, L., Xia, Y. and Chen, Y., 2019. Effect of government subsidies on renewable energy investments: The threshold effect. Energy Policy, [e-journal] 132(9), pp. 156-166. http://doi.org/10.1016/j.enpol.2019.05.039. Ye, X.Q., 2018. Free trade zones and economic growth-an empirical study based on quasinatural experiments. Economic Review, [e-journal] 4, pp. 18-30. https://doi.org/10.19361/j.er.2018.04.02. Yin, X., Ming, H., Cui, J. and Bao, X., 2021. Could Executive Compensation Incentive Enhance the Efficiency of Enterprise Resource Allocation? An Empirical Study from China. Discrete Dynamics in Nature and Society, [e-journal] 3, pp. 1-11. http://doi.org/10.1155/2021/7073878. Zhao, M., 2006. Conducting R&D in countries with weak intellectual property rights protection. Management Science, [e-journal] 52(8), pp. 1185-1199. http://doi.org/10.1287/mnsc.1060.0516. Zhao, X. and Lin, D.L., 2019. Research on the innovation effect of equity incentive: a dual role analysis based on R&D investment. Research and Development Management, [e-journal] 31(1), pp. 87-96. https://doi.org/CNKI:SUN:YJYF.0.2019-01-011. Zhang, D., Zhang, T. and Ma, G., 2020. Can non‐executive equity incentives reduce internal control ineffectiveness? Evidence from China. Accounting & Finance, [e-journal] 60(5), pp. 4467-4496. http://doi.org/10.1111/acfi.12653.