This study examines the role of intellectual property rights (IPRs) in contractual research and development (R&D) in developing countries. We find that strong IPRs provide incentives for firms, both multinational and local, to specialize in R&D activities in which they have competitive advantage (the specialization effect). They also facilitate the switching process from imitators to potential innovators for local firms (the switching effect). Moreover, we also demonstrate that a multinational firm's strategic IPRs enforcement behavior can be an effective instrument for subsidizing contractual R&D in developing countries (the subsidizing effect). We further illustrate how a policy mix of IPRs and a foreign direct investment subsidy in these countries affects R&D activities by adding an offshore R&D subsidiary as an additional organizational form. (JEL L13, O31, O34)