Branching morphogenesis of many organs, including the embryonic lung, is a dynamic process in which growth factor mediated tyrosine kinase receptor activation is required, but must be tightly regulated to direct ramifications of the terminal branches. However, the specific regulators that modulate growth factor signaling downstream of the tyrosine kinase receptor remain to be determined. Herein, we demonstrate for the first time an important function for the intracellular protein tyrosine phosphatase Shp2 in directing embryonic lung epithelial morphogenesis. We show that Shp2 is specifically expressed in embryonic lung epithelial buds, and that loss of function by the suppression of Shp2 mRNA expression results in a 53% reduction in branching morphogenesis. Furthermore, by intra-tracheal microinjection of a catalytically inactive adenoviral Shp2 construct, we provide direct evidence that the catalytic activity of Shp2 is required for proper embryonic lung branch formation. We demonstrate that Shp2 activity is required for FGF10 induced endodermal budding. Furthermore, a loss of Shp2 catalytic activity in the embryonic lung was associated with a reduction in ERK phosphorylation and epithelial cell proliferation. However, epithelial cell differentiation was not affected. Our results show that the protein tyrosine phosphatase Shp2 plays an essential role in modulating growth factor mediated tyrosine kinase receptor activation in early embryonic lung branching morphogenesis. © 2005 Elsevier Inc. All rights reserved.