Transforming growth factor beta 1 (TGF-1) has been implicated as a major negative regulator of lung branching morphogenesis. Since connective tissue growth factor (CTGF) is a down-stream mediator of TGF-1 effects on mesenchymal cells we hypothesized that TGF-1 induces CTGF expression in mouse embryonic lung explants and that CTGF mediates TGF-1 inhibition of branching morphogenesis. We show that addition of TGF-1 to the serum-free medium of E12.5 lung explant cultures inhibited branching morphogenesis and induced CTGF mRNA expression in time- and dose-dependent manners. In contrast to basal endogenous CTGF protein, which was exclusively localized in the distal airway epithelium, TGF-1-induced CTGF protein was localized in both the epithelium and the mesenchyme. Addition of exogenous CTGF to culture medium directly inhibited branching morphogenesis. To identify the signal transduction pathway through which TGF-1 induces CTGF, we used SB431542, a specific inhibitor for TGF-type I receptor (TRI)/ALK-5 to block TGF-1-induced Smad2/3 phosphorylation. Consequently, SB431542 stimulated normal branching morphogenesis and blocked TGF-1 inhibition of branching. Furthermore, SB-431542 blocked both endogenous and TGF-1-induced expression of CTGF mRNA and protein. These results demonstrate for the first time, that TGF-1 induces CTGF expression in mouse embryonic lung explants, that CTGF inhibits branching morphogenesis and that both endogenous and TGF-1-induced CTGF expression are mediated by the TRI/ALK-5-dependent Smad2 signaling pathway.