Mutations in the Drosophila gene extradenticle (exd), a homologue of the human proto-oncogene pbx1, cause homeotic transformations by altering the morphological consequences of homeotic selector gene activity. exd has been proposed to act by contributing to the specificity of selector homeodomain proteins for their downstream targets. Here we show that exd is indeed required for the appropriate regulation of at least some of these target genes. Expression patterns of wingless, teashirt and decapentaplegic (dpp) are altered in the embryonic midgut of embryos lacking exd, while the expression of their respective regulators (abd-A, Antp and Ubx) remains normal. Co-regulation of dpp by exd and Ubx was investigated in greater detail by examining the expression of reporter constructs in exd embryos. These experiments not only define dpp regulatory regions responsive to exd, but also distinguish two functions of exd in the regulation of dpp. exd acts with Ubx to activate dpp expression in parasegment 7 (PS7), via a minimal visceral mesoderm enhancer, and exd represses dpp expression anterior to PS7. We show that even when Ubx is ubiquitously expressed at high levels in exd embryos, Ubx is incapable of activating dpp enhancer expression. Thus, exd is an indispensable component in target gene regulation by the homeotic selector proteins.