We have recently demonstrated that the retinoblastoma family of negative cell cycle regulators can form complexes with a class of developmental factors which contain paired‐like (PL) homeodomains (Wiggan et al. [1998] Oncogene 16:227–236). Our screens led to the isolation of a novel PL‐homeodomain protein which had been isolated independently by another group and called Alx‐4 (Qu et al. [1997] Development 124:3999–4008). Mice homozygous for a targeted null mutation of Alx‐4 have several abnormalities, including preaxial polydactyly, suggesting that Alx‐4 plays a role in pattern formation in limb buds. In data that we present here, we show that Alx‐4 is expressed in mesenchymal condensations of a diverse group of tissues whose development is dependent on epithelial–mesenchymal interactions, many of which are additionally dependent on expression of the HMG‐box–containing protein, LEF‐1. Alx‐4–expressing tissues include osteoblast precursors of most bones, the dermal papilla of hair and whisker follicles, the dental papilla of teeth, and a subset of mesenchymal cells in pubescent mammary glands. We show further that Alx‐4 strongly activates transcription from a promoter containing the homeodomain binding site, P2. Optimal activation requires specific sequences in the N‐terminal portion of Alx‐4, as well as a proline‐rich region downstream of the PL‐homeodomain, but not the paired‐tail at the C terminus. Taken together, our results demonstrate that Alx‐4 is a potent transcriptional activator that is expressed at sites of epithelial–mesenchymal interactions during murine embryonic development. Dev. Dyn. 1998;213:159–169. © 1998 Wiley‐Liss, Inc.