Gene targeting has been used to direct mutations into specific chromosomal loci in murine embryonic stem (ES) cells. The altered locus can be studied in vivo with chimeras and, if the mutated cells contribute to the germ line, in their offspring. Although homologous recombination is the basis for the widely used gene targeting techniques, to date, the mechanism of homologous recombination between a vector and the chromosomal target in mammalian cells is essentially unknown. Here we look at the nature of gene targeting in ES cells by comparing an insertion vector with replacement vectors that target hprt. We found that the insertion vector targeted up to ninefold more frequently than a replacement vector with the same length of homologous sequence. We also observed that the majority of clones targeted with replacement vectors did not recombine as predicted. Analysis of the recombinant structures showed that the external heterologous sequences were often incorporated into the target locus. This observation can be explained by either single reciprocal recombination (vector insertion) of a recircularized vector or double reciprocal recombination/gene conversion (gene replacement) of a vector concatemer. Thus, single reciprocal recombination of an insertion vector occurs 92-fold more frequently than double reciprocal recombination of a replacement vector with crossover junctions on both the long and short arms.