We have examined the role that smooth muscle plays during prostatic organogenesis and propose that differentiation of a smooth muscle layer regulates prostatic induction by controlling mesenchymal/epithelial interactions. During development of the rat reproductive tract, an area of condensed mesenchyme involved in prostatic organogenesis is formed. This mesenchyme (the ventral mesenchymal pad, VMP) is found in both males and females, yet only males develop a prostate. We demonstrate that a layer of smooth muscle differentiates between the VMP and the urethral epithelium, and that there is a sexually dimorphic difference in the development of this layer. Serial section reconstruction showed that the layer formed at approximately embryonic day 20.5 in females, but did not form in males. In cultures of female reproductive tracts, testosterone was able to regulate the thickness of this layer resulting in a 2.4-fold reduction in thickness. We observed that prostatic buds were present in some female reproductive tracts, and determined that testosterone was able to stimulate prostatic organogenesis, depending upon the bud position relative to the smooth muscle layer. In vitro recombination experiments demonstrated that direct contact with the VMP led to the induction of very few epithelial buds, and that androgens dramatically increased bud development. Taken together, our data suggest that differentiation of a smooth muscle layer regulates signalling between mesenchyme and epithelium, and comprises part of the mechanism regulating prostatic induction.