We have previously identified proteolytic activity in rat liver microsomes that cleaves an intact tripeptide, VIS, from S-farnesylated-CVIS tetrapeptide. This enzymatic activity, termed prenyl protein-specific endoprotease (PPEP) activity, has been solubilized in CHAPS and purified 5-fold. To probe the peptide recognition features of PPEP activity, 64 tripeptides [N-acetyl-C(S-farnesyl)a(1)a(2)] were prepared and tested as competitive inhibitors of PPEP activity-catalyzed hydrolysis of N-acetyl-C(S-farnesyl)VI-[H-3]S. It was found that PPEP activity prefers large hydrophobic residues in the a(1) and a(2) positions. A subset of N-acetyl-C(S-farnesyl)a(1)a(2) peptides were prepared in radiolabeled form, and it was found that PPEP activity preferences for these substrates correlated well in most cases with the inhibition data. The exception is that R in the a(1) position does not prevent binding of peptide to PPEP activity, but such peptides are poor substrates. The anionic residue D in the a(2) position is not tolerated by PPEP activity. Five farnesylated radiolabeled tetrapeptides, Ac-C(F)FM[H-3]L, Ac-C(F)LI[H-3]L, Ac-C(F)LL[H-3]L, Ac-C(F)LM[(3)h]L, and Ac-C(F)VI[H-3]L were prepared, and PPEP activity kinetic studies revealed that they are good substrates and show comparable K-M values (2.2-13.5 mu M). Ac-C(F)RL[H-3]S is a poor substrate. The reported peptide binding preferences of PPEP activity should be useful in designing compounds that block the C-terminal proteolysis of prenylated proteins. Nonprenylated peptides do not bind to PPEP activity, and replacement of the farnesyl group with an n-pentadecyl group modestly reduces binding. Peptide-membrane partitioning studies were used together with theoretical arguments to fully understand the substrate specificity of PPEP activity toward these compounds.