To study the role of Cdc42 in the establishment of epithelial polarity during mammalian development, we generated murine Cdc42-null embryonic stem cells and analyzed peri-implantation development using embryoid bodies (EBs). Mutant EBs developed endoderm and underlying basement membrane, but exhibited defects of cell polarity, cell–cell junctions, survival, and cavitation. These defects corresponded to a decreased phosphorylation and membrane localization of aPKC, a reduced phosphorylation of GSK3β, and a diminished activity of Rac1. However, neither Rac1 nor the kinase function of GSK3β seem to contribute to cell polarization and cell–cell contacts. In contrast, EBs expressing dominant-negative (dn) PKCζ mimicked well the phenotype of Cdc42-null EBs, suggesting a major role of aPKC in mediating cell polarization downstream of Cdc42. Finally, aggregation experiments with endodermal cell lines suggested that Cdc42 might affect formation of adherens and tight junctions by PKCζ-dependent regulation of the protein levels of p120 catenin and E-cadherin. Developmental Dynamics 236:2767–2778, 2007. © 2007 Wiley-Liss, Inc.