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It has been hypothesised that many natural plant distribution patterns can be explained by a trade-off between shade and drought tolerance which would make plants more sensitive to shade under dry conditions. On the other hand, shading by nurse plants is often observed to enhance growth and survival of smaller plants in dry areas. This paper describes an experiment designed to address the interactive effects of drought and shade on growth and physiology of tulip poplar seedlings (Liriodendron tulipifera) grown in shade houses under different combinations of irradiance (1%, 5%, 12%, 17%, and 27% of ambient PAR) and soil water content (5–9%, 11–15%, and>20%). The results show no evidence that higher PAR levels compensate for the negative effects of drought on photosynthesis and growth. Rather, rates of estimated daily shoot carbon gain decreased with PAR under dry conditions. Daily xylem sapflow patterns indicated that this was associated with a strong reduction in stomatal conductance in plants growing in dry soil and high PAR conditions. Whole-shoot light compensation points were higher for plants raised under higher PAR conditions, but were not significantly influenced by the water treatments. Shoot dark respiration rates decreased under drier conditions. These results do not support the hypothesis of a trade-off between shade and drought tolerance. Instead, they indicate mechanisms that can lead to positive effects of shading by neighbouring plants under dry conditions. Indeed, such facilitation is thought to be important in many plant communities.