Purpose: A range of studies have shown difficulties in perceiving acoustic and phonetic information in dyslexia; however, much less is known about how such difficulties relate to the perception of individual words. The authors present data from event-related potentials (ERPs) examining the hypothesis that children with dyslexia have difficulties with processing phonemic information within spoken words compared to age-matched readers with typical development. Method: The authors monitored ERPs to auditory words during a simple picture-word matching task. The key manipulation was the inclusion of both matching stimuli and three types of mismatches (cohort, CONE- "comb"; rhyme, CONE- "bone"; and unrelated, CONE- "fox"). Results: Children with dyslexia showed atypical N400 ERP waveforms to both types of phonological mismatches, but not to phonologically unrelated mismatches, reflecting a relative insensitivity to phonological overlap among auditory words. Conclusion: The data suggest that children with dyslexia have impairments in integrating phonological information into word-level representations. The results suggest that speech perception difficulties in dyslexia might have consequences for processing auditory words.