ABSTRACT Little is known about the signal transduction pathways by which cells respond to mammalian TGF-βs or to decapentaplegic (dpp), a Drosophila TGF-β-related factor. Here we describe the genetic and molecular characterization of Drosophila schnurri (shn), a putative transcription factor implicated in dpp signaling. The shn protein has eight zinc fingers and is related to a human transcription factor, PRDII/MBPI/HIV-EP1, that binds to nuclear factor-κB-binding sites and activates transcription from the HIV long terminal repeat (LTR). shn mRNA is expressed in a dynamic pattern in the embryo that includes most of the known target tissues of dpp, including the dorsal blastoderm, the mesodermal germlayer and parasegments 4 and 7 of the midgut. Mutations in shn affect several developmental processes regulated by dpp including induction of visceral mesoderm cell fate, dorsal/ventral patterning of the lateral ectoderm and wing vein formation. Absence of shn function blocks the expanded expression of the homeodomain protein bagpipe in the embryonic mesoderm caused by ectopic dpp expression, illustrating a requirement for shn function downstream of dpp action. We conclude that shn function is critical for cells to respond properly to dpp and propose that shn protein is the first identified downstream component of the signal transduction pathway used by dpp and its receptors.