Evidence suggests that children with developmental dyslexia have poor phonological processing skills, are less likely to show lateralised activation during the processing of verbal information than children with normal reading ability and tend towards the left of the handedness continuum. The present study investigated this relationship between cerebral lateralisation and reading ability in children with and without dyslexia, directly using a dichotic listening paradigm with contemporaneous recording of auditory evoked potentials and indirectly using measures of hand preference and hand skill. The two groups were significantly different on a phonemic awareness task, particularly with reference to rime rather than phoneme onset. The two groups performed equally well on the dichotic listening task. However, normal readers produced significantly greater N100 amplitudes in the left temporal region during dichotic listening than the dyslexics who displayed approximately equivalent levels of amplitude bilaterally. In terms of hand preference the dyslexics were significantly less right-hand preferent than the controls, although the groups did not differ on a measure of right/left hand skill. The AEP lateralisation indices and the hand preference scores were significantly related to phonemic awareness performance. The different patterns of AEP activity produced by the two groups of children during the dichotic listening task and the differences in hand preference may be related to abnormal cerebral lateralisation of language functions. The failure of the dichotic listening task to discriminate between the two groups in spite of evidence of differences in cortical activation suggests that the processing difficulties which may be indexed by these differences in cortical activation affect the reading process at a later stage than that tapped by dichotic listening.