The development of hepatocellular carcinomas from malignant hepatocytes is frequently associated with intra‐ and peritumoral accumulation of connective tissue arising from activated hepatic stellate cells. For both tumorigenesis and hepatic fibrogenesis, transforming growth factor (TGF)‐β signaling executes key roles and therefore is considered as a hallmark of these pathological events. By employing cellular transplantation we show that the interaction of neoplastic MIM‐R hepatocytes with the tumor microenvironment, containing either activated hepatic stellate cells (M1‐4HSCs) or myofibroblasts derived thereof (M‐HTs), induces progression in malignancy. Cotransplantation of MIM‐R hepatocytes with M‐HTs yielded strongest MIM‐R generated tumor formation accompanied by nuclear localization of Smad2/3 as well as of β‐catenin. Genetic interference with TGF‐β signaling by gain of antagonistic Smad7 in MIM‐R hepatocytes diminished epithelial dedifferentiation and tumor progression upon interaction with M1‐4HSCs or M‐HTs. Further analysis showed that tumors harboring disrupted Smad signaling are devoid of nuclear β‐catenin accumulation, indicating a crosstalk between TGF‐β and β‐catenin signaling. Together, these data demonstrate that activated HSCs and myofibroblasts directly govern hepatocarcinogenesis in a TGF‐β dependent fashion by inducing autocrine TGF‐β signaling and nuclear β‐catenin accumulation in neoplastic hepatocytes. These results indicate that intervention with TGF‐β signaling is highly promising in liver cancer therapy. J. Cell. Physiol. 209: 560–567, 2006. © 2006 Wiley‐Liss, Inc.