Ring contraction of 3-hydroxy-2,4(1H,3H)-quinolinediones (1) in aqueous potassium hydroxide resulted in the formation of 2-hydroxyindoxyls and/or dioxindoles. The choice of N-substituent and the reaction conditions govern the chemoselectivity of the reaction. N-Phenyl-substituted derivatives 1 give 2-hydroxyindoxyls, while N-alkyl- and N-benzyl-substituted derivatives afford the corresponding dioxindols. On the basis of byproduct analysis, as well as independent experiments, the most plausible reaction mechanism is proposed.