Classic cadherins are adhesion-activated cell signaling receptors. In particular, homophilic cadherin ligation can directly activate Rho family GTPases and phosphatidylinositol 3-kinase (PI3-kinase), signaling molecules with the capacity to support the morphogenetic effects of these adhesion molecules during development and disease. However, the molecular basis for cadherin signaling has not been elucidated, nor is its precise contribution to cadherin function yet understood. One attractive hypothesis is that cadherin-activated signaling participates in stabilizing adhesive contacts (Yap, A. S., and Kovacs, E. M. (2003) J. Cell Biol. 160, 11-16). We now report that minimal mutation of the cadherin cytoplasmic tail to uncouple binding of p120-ctn ablated the ability of E-cadherin to activate Rac. This was accompanied by profound defects in the capacity of cells to establish stable adhesive contacts, defects that were rescued by sustained Rac signaling. These data provide direct evidence for a role of cadherin-activated Rac signaling in contact formation and adhesive stabilization. In contrast, cadherin-activated PI3-kinase signaling was not affected by loss of p120-ctn binding. The molecular requirements for E-cadherin to activate Rac signaling thus appear distinct from those that stimulate PI3-kinase, and we postulate that p120-ctn may play a central role in the E-cadherin-Rac signaling pathway.