CYP26A1, a cytochrome P450 enzyme, metabolizes all-trans-retinoic acid (RA) into polar metabolites, e.g. 4-oxo-RA and 4-OH-RA. To determine if altering RA metabolism affects embryonic stem (ES) cell differentiation, we disrupted both alleles of Cyp26a1 by homologous recombination. CYP26a1(-/-) ES cells had a 11.0+/-3.2-fold higher intracellular RA concentration than Wt ES cells after RA treatment for 48 h. RA-treated CYP26A1(-/-) ES cells exhibited 2-3 fold higher mRNA levels of Hoxa1, a primary RA target gene, than Wt ES cells. Despite increased intracellular RA levels, CYP26a1(-/-) ES cells were more resistant than Wt ES cells to RA-induced proliferation arrest. Transcripts for parietal endodermal differentiation markers, including laminin, J6(Hsp 47), and J31(SPARC, osteonectin) were expressed at lower levels in RA-treated CYP26a1(-/-) ES cells, indicating that the lack of CYP26A1 activity inhibits RA-associated differentiation. Microarray analyses revealed that RA-treated CYP26A1(-/-) ES cells exhibited lower mRNA levels than Wt ES cells for genes involved in differentiation, particularly in neural (Epha4, Pmp22, Nrp1, Gap43, Ndn) and smooth muscle differentiation (Madh3, Nrp1, Tagln Calponin, Caldesmon1). In contrast, genes involved in the stress response (e.g. Tlr2, Stk2, Fcgr2b, Bnip3, Pdk1) were expressed at higher levels in CYP26A1(-/-) than in Wt ES cells without RA. Collectively, our results show that CYP26A1 activity regulates intracellular RA levels, cell proliferation, transcriptional regulation of primary RA target genes, and ES cell differentiation to parietal endoderm.