Integral to the development of embryonic stem cell therapeutic strategies for hepatic disorders is the identification and establishment of a controllable hepatic differentiation strategy. In order to address this issue we have established an alginate microencapsulation approach which provides a means to modulate the differentiation process through changes in key encapsulation parameters. We report that a wide array of hepatocyte specific markers is expressed by ells differentiated during a 23-day period within an alginate bead microenvironment: These include urea and albumin secretion, glycogen storage, and cytochrome P450 transcription factor activity. In addition, we demonstrate that cellular aggregation is integral to the control of differentiation within the bead environment and this process is mediated by the E-cadherin protein. The temporal expression of surface E-cadherin and hepatocyte functional expression occur concomitantly and both cellular aggregation and albumin synthesis are blocked in the presence of anti E-cadherin immunoglobulin. Furthermore, by establishing a compartmental model of differentiation, which incorporates this aggregation phenomenon, we can optimize key encapsulation parameters.