A Sonic hedgehog (Shh) response element was identified in the chicken ovalbumin upstream promoter-transcription factor II (COUP-TFII) promoter that binds to a factor distinct from Gli, a gene known to mediate Shh signaling. Although this binding activity is specifically stimulated by Shh-N (amino-terminal signaling domain), it can also be unmasked with protein phosphatase treatment in the mouse cell line P19, and induction by Shh-N can be blocked by phosphatase inhibitors. Thus, Shh-N signaling may result in dephosphorylation of a target factor that is required for activation of COUP-TFII-, Islet1-, and Gli response element-dependent gene expression. This finding identifies another step in the Shh-N signaling pathway.