Coordinated growth and differentiation of external genitalia generates a proximodistally elongated structure suitable for copulation and efficient fertilization. The differentiation of external genitalia incorporates a unique process, i.e. the formation of the urethral plate and the urethral tube. Despite significant progress in molecular embryology, few attempts have been made to elucidate the molecular developmental processes for external genitalia. The sonic hedgehog (Shh) gene and its signaling genes have been found to be dynamically expressed during murine external genitalia development. Functional analysis by organ culture revealed that Shh could regulate mesenchymally expressed genes, patched 1 (Ptch1), bone morphogenetic protein 4 (Bmp4), Hoxd13 and fibroblast growth factor 10 (Fgf10), in the anlage: the genital tubercle (GT). Activities of Shh for both GT outgrowth and differentiation were also demonstrated. Shh(-/-) mice displayed complete GT agenesis, which is compatible with such observations. Furthermore, the regulation of apoptosis during GT formation was revealed for the first time. Increased cell death and reduced cell proliferation of the Shh(-/-) mice GT were shown. A search for alterations of Shh downstream gene expression identified a dramatic shift of Bmp4 gene expression from the mesenchyme to the epithelium of the Shh mutant before GT outgrowth. Regulation of mesenchymal Fgf10 gene expression by the epithelial Shh was indicated during late GT development. These results suggest a dual mode of Shh function, first by the regulation of initiating GT outgrowth, and second, by subsequent GT differentiation.