AbstractResearch question/issueInnovation has been a constant feature of the tales of transition and transformation. State ownership as the engine of innovation and technological change may be juxtaposed with the “liability of stateness” and the notion that “privatization works.” This study seeks to investigate the relationship between legal ownership and innovation inputs and outputs, while accounting for the moderating effect of institutional quality on this relationship.Research findings/insightsWe exploit unique data from a very large‐scale panel survey of enterprises (65,750 firms between 2006 and 2014) in Vietnam, a fast‐growing but understudied transition country, and apply advanced methodologies that control for the endogeneity of institutions. Our findings point to the continued dominance of state‐owned enterprises (SOEs) in innovation activities in Vietnam. However, the returns to innovation in SOEs accrue only up to a point and improving institutional quality serves to diminish their advantage over privately‐owned enterprises (POEs) and to level the playing field.Theoretical/academic implicationsWe employ an integrated framework that develops predictions from resource dependence, agency, and institutional theories to explore the direct and contingent influences of ownership and institutional quality on firm‐level innovation activities. Our study contributes to the growing literature on state ownership and innovation in transition and emerging economies and the recent calls for greater attention to local institutional context and revising the existing theories on “state underperformance.”Practitioner/policy implicationsThis study offers insights to policy makers in enhancing the quality of local institutions. Higher‐quality institutions moderate the advantages state ownership confers and ameliorate the disadvantages associated with private ownership.