This study analysed the effect of R&D subsidies on strategic decisions taken by firms when faced by innovation. The traditional approach of evaluating the impact of these subsidies on the net figure of R&D expenditures does not enable us to establish how public financing influences decisions involving technological knowledge generation, nor the economic returns which could be derived from this process. The study analyses these effects taking into consideration the size of the firm, since it is a widely used variable in designing innovation policies. The study revealed that public funding, regardless of size, mainly stimulated investments aimed at gaining knowledge within the firm’s technological domain, while it did not expand the technological knowledge frontier. The findings also show that subsidies only enhance the generation of incremental innovations in the case of small firms. The study concludes that the present approach to subsidies allocation is permitting the continuity of a certain strategic behaviour which specialises in leading the firm towards a quest for immediate results rather than constructing a sustainable competitive advantage.

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