The Src homology 2 (SH2) domain containing protein-tyrosine phosphatase SHP-2 contributes to prolactin receptor (PRLR) signal transduction to beta-casein gene promoter activation. We report for the first time that SHP-2 physically associates with the signal transducer and activator of transcription-5a (Stat5a), an important mediator of PRLR signaling to milk protein gene activation, in the mouse mammary HC11 and the human breast cancer T47D cells when stimulated with prolactin (PRL) and human growth hormone, respectively. In addition, overexpression studies indicate that the carboxyl-terminal SH2 domain of SHP-2 is required to maintain tyrosine phosphorylation of Stat5 and its interaction with SHP-2. Furthermore, we demonstrate by nuclear co-immunoprecipitation and indirect immunofluorescence studies that PRL stimulation of mammary cells leads to the nuclear translocation of SHP-2 as a complex with Stat5a. This process was found to involve the catalytic activity of the phosphatase. Finally, using the Stat5 GAS (gamma-activated sequence) element of the beta-casein gene promoter in electrophoretic mobility shift assays, we demonstrate that PRL induces the SHP-2-Stat5a complex to bind to DNA. The presence of the phosphatase in the protein-bound DNA complex was verified by using polyclonal antisera to SHP-2. Our studies indicate a tight physical and functional interaction between SHP2 and Stat5 required for regulation and perpetuation of PRL-mediated signaling in mammary cells and suggest a potential role for SHP-2 in the nucleus.