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This paper provides a theoretical model on the trade-offs a MNE faces when assigning subsidiaries an active role in innovation and organizing its R&D decentralized versus centralized. R&D decentralization avoids having to adapt centrally developed innovations to local markets, being able to use the specific know-how of the subsidiary. In addition R&D subsidiaries can be used to source locally available external know-how. But the MNE has to organize the transfer of local know-how internally so as to be able to benefit from this location specific know-how throughout the organization. At the same time, decentralization of R&D to the subsidiary level intensifies the challenge of effectively appropriating core technology know-how, preventing the spilling over of valuable know-how to competitors, located in the foreign markets. While R&D decentralization has repercussions on both intra-company technology transfers as well as inter company technology spillovers, it emerges as a possible equilibrium outcome from the resulting strategic interaction between the foreign subsidiary and local competition. The proposed model treats both internal and external spillovers in a game-theoretic context explicitly recognizing that absorptive capacity is required to be able to use external spillovers. The analysis suggests that a strong local know-how base is not a univocally positive factor for locating R&D abroad and indicates the critical complementary role of managing internal and external spillovers to capitalize on the benefits from R&D decentralization. It also shows that the intensity of product market competition in the host country is important, especially in determining the outgoing spillover costs. ispartof: DTEW Research Report 0146 pages:1-58 status: published