Abstract: Much of the prior research on R and D cooperation has focused on the role of technological spillovers, in this paper we extend our understanding of R and D cooperation by considering relative absorptive capacity, a firm’s ability to value, assimilate and utilize new external knowledge. The model incorporates horizontal spillovers, vertical spillovers and relative absorptive capacity and four types of R and D cooperation are studied: no cooperation, horizontal cooperation, vertical cooperation and simultaneous horizontal and vertical cooperation and the private incentives for R and D cooperation are addressed. It is found that upstream firms and downstream firms have divergent interests regarding the choice of cooperative settings and that technological spillovers and relative absorptive capacity increase the likelihood of the emergence of cooperation in a decentralized equilibrium.