Mg alloys are lightweight structural metals that are promising for a variety of engineering applications. However, use of Mg alloys is often restricted by their poor mechanical properties. Recent studies indicate that a novel laser-based surface processing technology, laser shock peening (LSP), is promising to improve the engineering performance of Mg alloys by enhancing their surface strength, biocompatibility, fatigue resistance, and anti-corrosion ability. Despite these experimental efforts, little attention has been paid to study the surface microstructure evolution in the LSP process, particularly the formation of high density deformation twins. Deformation twinning in hexagonal closed-packed (HCP) crystal structure plays a fundamental role in enhancing mechanical performance of Mg alloys. This research is to establish the process-microstructure relationship of Mg alloys as processed by LSP. A focus is placed on understanding the deformation twinning mechanism. LSP experiments are conducted on a rolled AZ31B Mg alloy. The microstructures before and after laser processing are characterized. The effect of laser intensity on the twin volume fraction is investigated. The surface hardness as associated with the twin density is measured. The mechanism responsible for the formation of gradient twinning microstructure and the twinning-induced hardening effect are discussed. The anisotropic response to LSP in terms of grain orientation and the resultant microstructure and hardness improvement in the Mg samples are discussed.