Decapentaplegic (Dpp) plays an essential role in Drosophila development, and analyses of the Dpp signaling pathway have contributed greatly to understanding of the actions of the TGF-beta superfamily. Intracellular signaling of the TGF-beta superfamily is mediated by Smad proteins, which are now grouped into three classes. Two Smads have been identified in Drosophila. Mothers against dpp (Mad) is a pathway-specific Smad, whereas Daughters against dpp (Dad) is an inhibitory Smad genetically shown to antagonize Dpp signaling. Here we report the identification of a common mediator Smad in Drosophila, which is closely related to human Smad4. Mad forms a heteromeric complex with Drosophila Smad4 (Medea) upon phosphorylation by Thick veins (Tkv), a type I receptor for Dpp. Dad stably associates with Tkv and thereby inhibits Tkv-induced Mad phosphorylation. Dad also blocks hetero-oligomerization and nuclear translocation of Mad. We also show that Mad exists as a monomer in the absence of Tkv stimulation. Tkv induces homo-oligomerization of Mad, and Dad inhibits this step. Finally, we propose a model for Dpp signaling by Drosophila Smad proteins.