This article presents a novel conceptual framework that uses the notion of knowledge sourcing to explain how firms realize benefits from R&D subsidies in terms of innovations. The study considers two dimensions of the firm’s knowledge sourcing: its R&D effort and level of openness to technology markets. This article proposes that the policy-induced effects of R&D subsidies on the knowledge-sourcing process increase firms’ innovation outcomes, thus making this policy intervention effective in promoting innovation. By using panel data from Spanish manufacturing firms, this article presents evidence consistent with the hypothesis that by changing the knowledge sourcing of firms, National R&D subsidy programs in Spain also favor more firm innovation, measured by patent applications and new product launches. It is also documented that the granting of R&D subsidies does not affect firm innovation directly but rather through inducing changes in the firm’s R&D effort and openness to technology markets.