The allocation of educational resources to students of different socio-economic backgrounds has important policy implications since it affects individual educational outcomes as well as the future distribution of human capital. In this paper, we present a theoretical model showing that local school administrators have an incentive to allocate weaker students to smaller classes. Then, using a rich individual-level dataset on secondary public schools in Israel, we provide evidence that weaker students are, indeed, systematically placed in smaller classes, thus exhibiting a compensatory allocation scheme. Moreover, schools with enrollment levels just over cut-off points induced by a maximum class size rule are systematically weaker than schools with enrollment levels just under those cut-offs. This finding indicates that not only do local school administrators allocate students into classes in a compensatory manner, but they also manipulate the class-size rule to achieve such an allocation. Potential implications of these results are discussed. (Contains 2 figures and 7 tables.)