The ability of stem cells to generate distinct fates is critical for the generation of cellular diversity during development. Central nervous system (CNS) stem cells respond to bone morphogenetic protein (BMP) 4 by differentiating into a wide variety of dorsal CNS and neural crest cell types. We show that distinct mechanisms are responsible for the generation of two of these cell types, smooth muscle and glia. Smooth muscle differentiation requires BMP-mediated Smad1/5/8 activation and predominates where local cell density is low. In contrast, glial differentiation predominates at high local densities in response to BMP4 and is specifically blocked by a dominant-negative mutant Stat3. Upon BMP4 treatment, the serine-threonine kinase FKBP12/rapamycin-associated protein (FRAP), mammalian target of rapamycin (mTOR), associates with Stat3 and facilitates STAT activation. Inhibition of FRAP prevents STAT activation and glial differentiation. Thus, glial differentiation by BMP4 occurs by a novel pathway mediated by FRAP and STAT proteins. These results suggest that a single ligand can regulate cell fate by activating distinct cytoplasmic signals.