Smad7 was recently shown to antagonize TGF-beta-induced activation of signal-transducing Smad2 and Smad3 proteins. However, the biological function of Smad7 in the process of lung organogenesis is not known. Since Smad2/3-mediated TGF-beta signaling is known to inhibit embryonic lung branching morphogenesis, we tested the hypothesis that Smad7 regulates early lung development by modulating TGF-beta signal transduction. An antisense oligodeoxynucleotide (ODN) was designed to specifically block endogenous Smad7 gene expression at both transcriptional and translational levels in embryonic mouse lungs in culture. TGF-beta-mediated inhibition of lung branching morphogenesis was significantly potentiated in cultured embryonic lungs in the absence of Smad7 gene expression: abrogation of Smad7 potentiated TGF-beta-mediated inhibition of lung branching morphogenesis from 76 to 52% of the basal level in lungs cultured in the presence of 5 ng/ml TGF-beta1 ligand. Likewise, TGF-beta1 EC(50) (concentration of TGF-beta1 that induced half maximal branching inhibition) was reduced from 5 to 1 ng/ml when Smad7 gene expression was abrogated in lung culture, indicating an enhanced level of TGF-beta signaling in lung tissue with abolished Smad7 gene expression. By immunocytochemistry, Smad7 protein was co-localized with both Smad2 and Smad3 in distal bronchial epithelial cells, supporting the concept that Smad7 inhibits TGF-beta signaling by competing locally with Smad2 and Smad3 for TGF-beta receptor complex binding during lung morphogenesis. Furthermore, antisense Smad7 ODN increased the negative effect of TGF-beta1 on epithelial cell growth in developing lungs in culture. We also demonstrated that Smad7 mRNA levels were rapidly and potently induced upon TGF-beta1 stimulation of lungs in culture, suggesting that Smad7 regulates TGF-beta responses in a negative feedback loop. These studies define a novel function for Smad7 as an intracellular antagonist of TGF-beta-induced, Smad2/3-mediated inhibition of murine embryonic lung growth and branching morphogenesis in culture. The optimization of TGF-beta signaling during early lung development therefore requires a finely-regulated competitive balance between both permissive and inhibitory members of the Smad family.