Tyrosine phosphorylation of membrane proteins plays a crucial role in cell signaling by recruiting Src homology 2 (SH2) domain-containing signaling molecules. Recently, we have isolated a transmembrane protein designated PZR that specifically binds tyrosine phosphatase SHP-2, which has two SH2 domains (Zhao, Z. J., and Zhao, R. (1998) J. Biol. Chem. 273, 29367-29372). PZR belongs to the immunoglobulin superfamily. Its intracellular segment contains four putative sites of tyrosine phosphorylation. By site-specific mutagenesis, we found that the tyrosine 241 and 263 embedded in the consensus immunoreceptor tyrosine-based inhibitory motifs VIYAQL and VVYADI, respectively, accounted for the entire tyrosine phosphorylation of PZR. The interaction between PZR and SHP-2 requires involvement of both tyrosyl residues of the former and both SH2 domains of the latter, since its was disrupted by mutating a single tyrosyl residue or an SH2 domain. Overexpression of catalytically inactive but not active forms of SHP-2 bearing intact SH2 domains in cells caused hyperphosphorylation of PZR. In vitro, tyrosine-phosphorylated PZR was efficiently dephosphorylated by the full-length form of SHP-2 but not by its SH2 domain-truncated form. Together, the data indicate that PZR serves not only as a specific anchor protein of SHP-2 on the plasma membrane but also as a physiological substrate of the enzyme. The coexisting binding and dephosphorylation of PZR by SHP-2 may function to terminate signal transduction initiated by PZR and SHP-2 and to set a threshold for the signal transduction to be initiated.