Congenital tufting enteropathy (CTE) is a severe autosomal recessive human diarrheal disorder with characteristic intestinal epithelial dysplasia. CTE can be caused by mutations in genes encoding EpCAM, a putative adhesion molecule, and HAI-2, a cell surface protease inhibitor. A similar phenotype occurs in mice whose intestinal epithelial cells (IECs) fail to express the tight junction-associated protein claudin-7. EpCAM stabilizes claudin-7 in IECs, and HAI-2 regulates the cell surface serine protease matriptase, a known modifier of intestinal epithelial physiology. Therefore, we hypothesized that HAI-2, matriptase, EpCAM, and claudin-7 were functionally linked. Herein we have demonstrated that active matriptase cleaves EpCAM after Arg80 and that loss of HAI-2 in IECs led to unrestrained matriptase activity and efficient cleavage of EpCAM. Cleavage of EpCAM decreased its ability to associate with claudin-7 and targeted it for internalization and lysosomal degradation in conjunction with claudin-7. CTE-associated HAI-2 mutant proteins exhibited reduced ability to inhibit matriptase and also failed to efficiently stabilize claudin-7 in IECs. These results identify EpCAM as a substrate of matriptase and link HAI-2, matriptase, EpCAM, and claudin-7 in a functionally important pathway that causes disease when it is dysregulated.