In developing countries, ecological transfer payments (ETPs) are a preferred method of solving the dilemma of environmental governance. However, the associated policy effects have not yet been effectively evaluated. We use unique ETPs' data provided by the Ministry of Finance of China in a dynamic spatial panel data model. Our study finds that ETPs stimulate the efforts of local governments to improve environmental quality, and play a coordinated role in mitigating the race-to-the-bottom competition among regions. However, these transfer payments (TPs) do not promote ecological improvement. Although the design of non-ecological transfer payments (non-ETPs) considers ecological and environmental factors, they do not effectively play an incentive and coordinated role. The ETPs' behavior that encourages local governments to invest in environmental improvements exhibits more of a compensation rather than a leverage effect. This conclusion suggests that policymakers should pay attention to the coordinated role, and increase the weight of ecological factors, in the design of TPs. •The incentive and coordination effects of ETP are carried out.•The unique datas of ETP provided by the Ministry of Finance of China are used.•The coordination effect is mainly discussed through the spatial interaction term.•The incentive and coordination effects of different transfer payment were compared.•The mechanism analysis was focused upon government expenditure on environment.