BACKGROUND: The theory that prefrontal cortex (PFC) dysfunction in schizophrenia leads to excess subcortical dopamine has generated widespread interest because it provides a parsimonious account for two core features of schizophrenia, cognitive deficits and psychosis, respectively. However, there has been limited empirical validation of this model. Moreover, the identity of the specific subcortical brain regions and circuits that may be impaired as a result of PFC dysfunction and mediate its link to psychosis in schizophrenia remains unclear. We undertook this event-related functional magnetic resonance imaging study to test the hypothesis that PFC dysfunction is associated with altered function of and connectivity with dopamine regulating regions of the basal ganglia. METHODS: Eighteen individuals with schizophrenia or schizoaffective disorder and 19 healthy control participants completed event-related functional magnetic resonance imaging during working memory. We conducted between-group contrasts of task-evoked, univariate activation maps to identify regions of altered function in schizophrenia. We also compared the groups on the level of functional connectivity between a priori identified PFC and basal ganglia regions to determine if prefrontal disconnectivity in patients was present. RESULTS: We observed task-evoked hyperactivity of the substantia nigra that occurred in association with prefrontal and striatal hypoactivity in the schizophrenia group. The magnitude of prefrontal functional connectivity with these dysfunctional basal ganglia regions was decreased in the schizophrenia group. Additionally, the level of nigrostriatal functional connectivity predicted the level of psychosis. CONCLUSIONS: These results suggest that functional impairments of the prefrontal striatonigral circuit may be a common pathway linking the pathogenesis of cognitive deficits and psychosis in schizophrenia.