The European Commission has recently launched its new strategy Europe 2020. The first out of five priorities is given to the development of smart growth which means strengthening knowledge and innovation as drivers of future growth. Policy should stimulate research and development activities (R&D) of firms due to market failure. Market failure typically occurs because the R&D conducting firm cannot fully appropriate the returns of its R&D project. Due to the fact that knowledge is (partly) a public good that spills over to other firms, third parties can use the knowledge for imitation or further innovation. In Germany, direct R&D subsidies constitute the main policy instrument to fuel innovation.  In order to evaluate the efficiency of project selection by the public funding agency one needs to observe the innovative outcome of R&D projects that received public funding and compare it with the innovative outcome of purely privately financed R&D projects. In contrast to previous research we are able to construct a unique database that comprises the information whether a patent resulted from a subsidized R&D project or a purely privately financed one, and link this patent data to firm-level data and project-level data of the funded R&D projects.Using the data, we want to analyse if the German funding agency distributes subsidies to R&D projects in industry and academia efficiently. Specifically, we will investigate (i) if the probability to patent is lower for funded R&D projects indicating lower private returns, and (ii) if the social value of patents is higher for funded projects indicating higher social returns. In addition, we will exploit the fact that intellectual property rights for patents resulting from subsidised projects where strengthened by a policy reform in 1998. This quasi-experimental situation allows us to analyse the impact of the strengthening of IP rights on the agents’ patenting behaviour. The project thus aims to contribute to a deeper understanding of policy rationales, the design of appropriate policy instruments, as well as their effectiveness and efficiency.