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This study examines how state subsidies to firms affect corporate investment efficiency. Using archival data from a sample of Chinese listed firms over the 2007–2015 period, we find that government subsidies have a negative effect on firms' investment efficiency, and this negative effect is more pronounced for firms that are less financially constrained. Further analyses suggest that government subsidies are positively associated with firms' over-investment, although they alleviate under-investment. Our findings are robust to a series of tests to alleviate concerns about potential endogeneity and self-selection bias. • We ask if financial subsidies received from the state affect investment efficiency. • A negative effect is found that is more pronounced for less financially constrained firms. • Subsidies do alleviate under-investment. • But subsidies are positively associated with over-investment. [ABSTRACT FROM AUTHOR]