Since the bone morphogenetic proteins (BMPs) are members of the transforming growth factor-beta (TGF-beta) superfamily that induce the differentiation of mesenchymal precursor cells into the osteogenic cells, we identified the relevant signaling molecules responsible for mediating BMP-2 effects on mesenchymal precursor cells. BMP-2 induces osteoblastic differentiation of the pluripotent mesenchymal cell line C2C12 by increasing alkaline phosphatase activity and osteocalcin production. As recent studies have demonstrated that cytoplasmic Smad proteins are involved in TGF-beta superfamily signaling, we plan to isolate the relevant Smad family members involved in osteoblastic differentiation. We identified human Smad5, which is highly homologous to Smad1. BMP-2 caused serine phosphorylation of Smad5 as well as Smad1. In contrast, TGF-beta failed to cause serine phosphorylation of Smad1 and Smad5. We found Smad5 is directly activated by BMP type Ia or Ib receptors through physical association with these receptors. Following phosphorylation, Smad5 bound to DPC4, another Smad family member, and the complex was translocated to the nucleus. Overexpression of point-mutated Smad5 (G419S) or a C-terminal deletion mutant DPC4 (DPC4 delta C) blocked the induction of alkaline phosphatase activity, osteocalcin production, and Smad5-DPC4 signaling cascades upon BMP-2 treatment in C2C12 cells. These data suggest that activation of Smad5 and subsequent Smad5-DPC4 complex formation are key steps in the BMP signaling pathway, which mediates BMP-2-induced osteoblastic differentiation of the C2C12 mesenchymal cells.