Epithelial-mesenchymal interactions are critical for the branching and differentiation of the lung, but the mechanisms involved are still unclear. To investigate this problem in mouse embryonic lung we have studied the temporal and spatial expression of factors implicated in the morphogenesis of other organs. At 11.5 days post coitum (p.c.) hepatocyte nuclear factor-3β (HNF-3β) is expressed uniformly throughout the epithelium; whereas Wnt-2 expression is confined to the distal mesenchyme. Sonic hedgehog (Shh) transcripts are found at low levels throughout the epithelium but at high levels in the distal tips of the terminal buds. Epithelial expression is also seen for bone morphogenetic protein-7 (Bmp-7), but transcripts are less dramatically upregulated at the distal tips. The Type I Bone morphogenetic protein receptor (Bmpr/TFR-11, Brk-1) is expressed at low levels in the epithelium and in the distal mesenchyme. Finally, Bmp-4 transcripts are localized at high levels in the distal tips of the epithelium and in the adjacent mesenchyme. To study further the role of Bmp-4 in lung development, we have misexpressed the gene throughout the distal epithelium of transgenic embryos using a surfactant protein C enhancer/promoter. From 15.5 days p.c. transgenic lungs are smaller than normal, with grossly distended terminal buds, and at birth, contain large airfilled sacs which do not support normal lung function. Labeling with bromodeoxyuridine reveals an inhibition of epithelial proliferation in 15.5 days p.c. transgenic lungs. A small but significant stimulation of proliferation of mesenchymal cells is also observed, but this is accompanied by an increase in apoptosis. In situ hybridization with riboprobes for the proximal airway marker, CC10, and the distal airway marker, SP-C, shows normal differentiation of bronchiolar Clara cells but a reduction in the number of differentiated Type II cells in transgenic lungs. A model is proposed for the role of Bmp-4 and other signalling molecules in embryonic lung morphogenesis