Exploiting a quasi-natural experiment, which involves the imposition of a ban by Germany in 1994 on an input (‘Azo-dyes’) used by the Indian leather and textile industries, we estimate the indirect impact of the environmental regulation on innovation activities of upstream (dye-producing) firms in India and examine how it varies by different firm characteristics: size and ownership. We find robust evidence of a significant increase (11–61%) in innovation expenditure for the dye-makers in response to the ‘Azo-dyes’ ban. Additionally, we find: (i) increase in technology transfer to the tune of 1.2–2.5 times more than that of internal R&D; (ii) increase in innovation expenditure with firm size; (iii) domestic firms investing more in technology transfer as compared to R&D, whereas foreign firms only undertaking the latter and (iv) decrease in investments towards innovation by downstream firms, thereby pointing towards a possible substitution effect in aggregate innovation by upstream firms. Our results are consistent with a variety of estimation methods and robustness checks.