ABSTRACT: The formation of highly branched epithelial structures is critical for the development of many essential organs, including lung, liver, pancreas, kidney and mammary glands. Elongation and branching of these structures require precise control of complex morphogenetic processes that are dependent upon coordinate regulation of cell shape, apical-basal polarity, proliferation, migration, and interactions among multiple cell types. Herein, we demonstrate that temporal-spatial regulation of epithelial cell polarity by the small GTPase, CDC42, is essential for branching morphogenesis of the developing lung. Epithelial cell-specific deletion of CDC42 in fetal mice disrupted epithelial cell polarity, the actin cytoskeleton, intercellular contacts, directional trafficking of proteins, proliferation and mitotic spindle orientation, impairing the organization and patterning of the developing respiratory epithelium and adjacent mesenchyme. Transition from a pseudostratified to a simple columnar epithelium was impaired, consistent with coordinate dysregulation of epithelial cell polarity, mitotic spindle orientation, and repositioning of mitotic cells within the epithelium during cell cycle progression. Expression of sonic hedgehog and its receptor, patched-1, was decreased, while fibroblast growth factor 10 expression in the mesenchyme was expanded, resulting in disruption of branching morphogenesis and bronchiolar smooth muscle formation in this model. CDC42 is required for spatial positioning of proliferating epithelial cells, as well as signaling interactions between the epithelium and mesenchyme and is, therefore, essential for formation and maintenance of the respiratory tract during morphogenesis of the fetal lung.