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 genes implicated in the morphogenesis of other organs. At 11.5 days p.c., hepatocyte nuclear factor-3beta (Hnf-3beta) is expressed uniformly throughout the epithelium, while Wnt-2 expression is confined to the distal mesenchyme. Sonic hedgehog (Shh) transcripts are found throughout the epithelium, with high levels in the distal tips of the terminal buds, while bone morphogenetic protein-4 (Bmp-4) transcripts are localized at high levels in the distal tips of the epithelium, with lower levels in the adjacent mesenchyme. Epithelial expression is also seen for Bmp-7, but transcripts are less dramatically upregulated at the distal tips. The Type I Bone morphogenetic protein receptor gene (Bmpr/Tfr-11/Brk-1) is expressed at low levels in the epithelium and in the distal mesenchyme. To investigate the role of Bmp-4 in lung development, we have misexpressed the gene throughout the distal epithelium of transgenic lungs 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 air-filled sacs which do not support normal lung function. Labeling with BrdU reveals an inhibition of epithelia] 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 cell death. 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 BMP4 and other signalling molecules in embryonic lung morphogenesis.