Congenital diaphragmatic hernia (CDH) is characterized by incomplete closure of the diaphragm. While the ensuing compression to the fetal lung causes lung hypoplasia, specific cellular phenotypes and developmental signaling defects in the alveolar epithelium in CDH are not fully understood. Employing lung samples from human CDH, a surgical lamb model and a nitrogen rat model, we investigate whether lung compression impairs alveolar epithelial differentiation and Yes-associated protein (YAP)-mediated mechanosensing. We showed that CDH in humans and lambs caused defective alveolar epithelial differentiation manifested by more abundant ATII cells, fewer ATI cells, and the emergence of cells expressing both ATI and ATII markers. Associated with the alveolar epithelial defects, we found a decrease in the level and nuclear localization of YAP. Reduced nuclear YAP and abnormal distal lung development were evident as early as 21 weeks in gestation in human CDH. In addition, rat fetuses with CDH also showed diminished nuclear YAP and mor abundant ATII cells. In contrast, the littermates without the hernia had no such alveolar phenotypes. Furthermore, fetal tracheal occlusion (TO) in the surgical lamb model of CDH fully normalized nuclear YAP and rescued alveolar epithelial defects in a gestational age-dependent manner. Taken together, our findings across species indicate that lung compression in CDH is sufficient to disrupt alveolar epithelial differentiation and impair YAP signaling. TO can restore nuclear YAP and rescue the alveolar defects in CDH, depending on the timing and the duration of this prenatal surgical intervention. This article is open access and distributed under the terms of the Creative Commons Attribution Non-Commercial No Derivatives License 4.0 (http://creativecommons.org/licenses/by-nc-nd/4.0/).