The basal cells in epithelium of the erythematous form of oral lichen display hyperproliferation compared with normal oral mucosa. In this study we examined whether this is associated with disrupted production, activation, or signal transduction of the epithelial growth inhibitor transforming growth factor (TGF) beta1. In situ immunostaining showed that most epithelial cells in normal oral mucosa had nuclear and cytoplasmic Smad4 and phosphorylated Smad2/3, but expressed little or no Smad7. Expression of latency-associated peptide TGF-beta1, latent TGF-beta binding protein 1, TGF-beta type I receptor, and TGF-beta type II receptor was readily seen, but only very little TGF-beta1 was activated. In erythematous oral lichen, basal and lower spinous epithelial layers showed staining for latency-associated peptide TGF-beta1, TGF-beta type I receptor, and TGF-beta type II receptor. A band with scanty staining for these molecules, but with marked staining for active TGF-beta1, was seen in the upper spinous and granular layers. Numbers of epithelial cell nuclei with Smad4 and phosphorylated Smad2/3 staining were significantly reduced in erythematous oral lichen compared with normal oral mucosa. Basal and suprabasal cell layers in erythematous oral lichen showed strong cytoplasmic Smad7 protein staining, but in spinous and granular layers Smad7 was localized to the cell membrane. In situ hybridization showed strong Smad7 mRNA expression in almost all basal keratinocytes in erythematous oral lichen; by contrast, no or occasionally very weak Smad7 mRNA expression was seen in these cells in normal oral mucosa. The observations indicate that inhibition of the TGF-beta/Smad pathway may account for the hyperproliferation of keratinocytes in erythematous oral lichen.