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The knowledge spillover theory of entrepreneurship (KSTE) predicts a positive relationship between knowledge creation and entrepreneurial activity. As a transitional economy, China exhibits great differences among regions in advancing market reforms and opening-up, largely due to the gradual nature of its economic transformation and opening-up. This situation provides a suitable setting for exploring the role of the institutional environment in the KSTE framework. In this study, we discuss the applicability of the KSTE in the Chinese context and theoretically analyze the role of the institutional environment from aspects of market reforms and opening-up. An empirical analysis based on the data of the Chinese manufacturing sector shows that the KSTE is applicable in China and it is applicable to industries with different technology levels and regions with different levels of economic development. More importantly, we find that both market reforms and opening-up strengthen the positive effect of knowledge creation on entrepreneurship. Our exploration in this field extends the KSTE.