Epithelial‐mesenchymal interactions are essential for tissue patterning during organogenesis. Distal lung epithelium and its adjacent mesenchyme comprise the epithelial‐mesenchymal signaling unit that regulates lung branching morphogenesis. Tissue recombination experiments have demonstrated the importance of mesenchymal signals in inducing lung epithelial differentiation and branching, but the role of the epithelium in regulating mesenchymal signals has not been well characterized. Using transgenic mice, we ablated distal lung epithelial cells during lung development by inducing the expression of a constitutively active proapoptotic Bax protein under the surfactant protein C (SP‐C) promoter. We found that epithelial cell ablation results in impaired lung branching morphogenesis, which progresses to emphysematous airspaces in the adults. Mesenchymal expression of fibroblast growth factor 10 (Fgf‐10), whose strict spatial and temporal expression is critical for proper lung branching morphogenesis, is disrupted and loses its localized pattern. Interestingly, the expression of sonic hedgehog (Shh), an epithelial gene known to modulate Fgf‐10 expression, is unchanged, indicating the existence of other distal epithelial signals that regulate mesenchymal Fgf‐10expression. We propose that distal SP‐C expressing lung epithelial cells provide essential signals for the downregulation of Fgf‐10expression in the distal mesenchyme during lung development. 292:123–130, 2009. © 2008 Wiley‐Liss, Inc.