Most receptor-like protein tyrosine phosphatases (PTPases) display a high degree of homology with cell adhesion molecules in their extracellular domains. We studied the functional significance of processing for the receptor-like PTPases LAR and PTPsigma. PTPsigma biosynthesis and intracellular processing resembled that of the related PTPase LAR and was expressed on the cell surface as a two-subunit complex. Both LAR and PTPsigma underwent further proteolytical processing upon treatment of cells with either calcium ionophore A23187 or phorbol ester TPA. Induction of LAR processing by TPA in 293 cells did require overexpression of PKCalpha. Induced proteolysis resulted in shedding of the extracellular domains of both PTPases. This was in agreement with the identification of a specific PTPsigma cleavage site between amino acids Pro821 and Ile822. Confocal microscopy studies identified adherens junctions and desmosomes as the preferential subcellular localization for both PTPases matching that of plakoglobin. Consistent with this observation, we found direct association of plakoglobin and beta-catenin with the intracellular domain of LAR in vitro. Taken together, these data suggested an involvement of LAR and PTPsigma in the regulation of cell contacts in concert with cell adhesion molecules of the cadherin/catenin family. After processing and shedding of the extracellular domain, the catalytically active intracellular portions of both PTPases were internalized and redistributed away from the sites of cell-cell contact, suggesting a mechanism that regulates the activity and target specificity of these PTPases. Calcium withdrawal, which led to cell contact disruption, also resulted in internalization but was not associated with prior proteolytic cleavage and shedding of the extracellular domain. We conclude that the subcellular localization of LAR and PTPsigma is regulated by at least two independent mechanisms, one of which requires the presence of their extracellular domains and one of which involves the presence of intact cell-cell contacts.