Abstract: This paper analyzes theoretically the compliance costs effect and innovation compensating effect of environmental regulation on enterprise innovation. Under these two kinds of mechanism, the effect of environmental regulation on innovation depends on the degree of environmental regulation showing U-shaped nonlinear relations. We use the Chinese industrial enterprises data to test empirically this impact. The results show that: environmental regulation and production innovation show a U-shaped relationship. For most enterprises current environmental regulation intensity has not yet reached the inflection point of the U-shaped curve and still in the stage of the downward phase of the U-shaped curve. At the same time, on the basis of the corporate pollution degree for sub sectors, the U-shaped curve inflection point of heavily polluting industries located in the right side of the slightly polluted industries’. Therefore heavily polluting enterprises need higher environmental regulation intensity to achieve the inflection point of U-shaped curve and promote enterprise product innovation. Therefore, We treat the relationship between environmental regulation and innovation with the perspective of development, strengthen environmental regulation, and formulate different environmental policies for different enterprises. Only in this way can make environmental regulation become the impetus of enterprise innovation and achieve a win-win economic growth and environmental protection.