This study explores how informal sector competition influences the innovation strategies of formal emerging economy firms (FEEFs), focusing on the novel concept of ‘innovation time off,’ where employees are given discretionary time to pursue new ideas. Using data about Indian firms from the World Bank Enterprise Survey, the findings show that informal competition drives FEEFs to adopt innovation time off, though this effect diminishes for firms that are located in SEZs or have numerical labour flexibility. This study advances strategic management literature by offering actionable insights into the interplay of informal competition, innovation, and policy-induced firm characteristics in resource-constrained environments.