The pancreas emerges independently from dorsal and ventral domains of embryonic gut endoderm. Gene inactivation experiments in mice have identified factors required for dorsal pancreas development, but factors that initiate the ventral pancreas have remained elusive. In this study, we investigated the hypothesis that the emergence of the ventral pancreas is related to the emergence of the liver. We find that the liver and ventral pancreas are specified at the same time and in the same general domain of cells. Using embryo tissue explantation experiments, we find that the default fate of the ventral foregut endoderm is to activate the pancreas gene program. FGF signalling from the cardiac mesoderm diverts this endoderm to express genes for liver instead of those for pancreas. No evidence was found to indicate that the cell type choice for pancreas or liver involves a selection for growth or viability. Cardiac mesoderm or FGF induces the local expression of sonic hedgehog, which in turn is inhibitory to pancreas but not to liver. The bipotential precursor cell population for pancreas and liver in embryonic development and its fate selection by FGF has features that appear to be recapitulated in the adult pancreas and are reflected in the evolution of these organs.