Binding of macrophage colony stimulating factor (M-CSF) to its receptor (Fms) induces dimerization and activation of the tyrosine kinase domain of the receptor, resulting in autophosphorylation of cytoplasmic tyrosine residues used as docking sites for SH2-containing signaling proteins that relay growth and development signals. To determine whether a distinct signaling pathway is responsible for the Fms differentiation signal versus the growth signal, we sought new molecules involved in Fms signaling by performing a two-hybrid screen in yeast using the autophosphorylated cytoplasmic domain of the wild-type Fms receptor as bait. Clones containing SH2 domains of phospholipase C-γ2 (PLC-γ2) were frequently isolated and shown to interact with phosphorylated Tyr721 of the Fms receptor, which is also the binding site of the p85 subunit of phosphatidylinositol 3-kinase (PI3-kinase). At variance with previous reports, M-CSF induced rapid and transient tyrosine phosphorylation of PLC-γ2 in myeloid FDC-P1 cells and this activation required the activity of the PI3-kinase pathway. The Fms Y721F mutation strongly decreased this activation. Moreover, the Fms Y807F mutation decreased both binding and phosphorylation of PLC-γ2 but not that of p85. Since the Fms Y807F mutation abrogates the differentiation signal when expressed in FDC-P1 cells and since this phenotype could be reproduced by a specific inhibitor of PLC-γ, we propose that a balance between the activities of PLC-γ2 and PI3-kinase in response to M-CSF is required for cell differentiation.