Functional development of mammary epithelium during pregnancy depends on prolactin signaling. However, the underlying molecular and cellular events are not fully understood. We examined the specific contributions of the prolactin receptor (PrlR) and the signal transducers and activators of transcription 5a and 5b (referred to as Stat5) in the formation and differentiation of mammary alveolar epithelium. PrlR- and Stat5-null mammary epithelia were transplanted into wild-type hosts, and pregnancy-mediated development was investigated at a histological and molecular level. Stat5-null mammary epithelium developed ducts but failed to form alveoli, and no milk protein gene expression was observed. In contrast, PrlR-null epithelium formed alveoli-like structures with small open lumina. Electron microscopy revealed undifferentiated features of organelles and a perturbation of cell-cell contacts in PrlR- and Stat5-null epithelia. Expression of NKCC1, an Na-K-Cl cotransporter characteristic for ductal epithelia, and ZO-1, a protein associated with tight junction, were maintained in the alveoli-like structures of PrlR- and Stat5-null epithelia. In contrast, the Na-Pi cotransporter Npt2b, and the gap junction component connexin 32, usually expressed in secretory epithelia, were undetectable in PrlR- and Stat5-null mice. These data demonstrate that signaling via the PrlR and Stat5 is critical for the proliferation and differentiation of mammary alveoli during pregnancy.