Identifying the specific bioactive molecules produced by mesenchymal stem cells (MSCs) and the signaling pathways and cell types upon which they act is critical to developing MSC-based therapeutics for inflammatory diseases with high unmet needs. Our study aimed to investigate the impact of extracellular vesicle (EV)-derived TNF-Stimulated Gene-6 (TSG-6, from adipose tissue-derived mesenchymal stem cell concentrated conditioned medium, ASC-CCM or TSG-6 overexpression in ASC using ORF expression-ready clone) on microglia and its potential anti-inflammatory effects. EV but not non-vesicular secretome prepared by ultracentrifugation confirmed the expression of TSG-6 exclusively in the small EV (sEV) fraction. sEV ranged from 50–150 nm as determined by Zetasizer, demonstrated bilipid membrane evidenced by transmission electron microscopy, expressed positive exosomal (e.g. CD63) markers, and were endocytosed by BV2 cells confirmed by DiI fluorescently labeled exosomes. BV2 microglia cultured under serum-free conditions stimulated with TLR4 agonists (LPS and IFNγ) for 12 h in the presence of p-ASC-EV (sEV derived from ASC after cytokine stimulation) and TSG-6-ORF-EV significantly reduced nitrite release (p < 0.001), phagocytic activity (p < 0.001) and reduced CD44 expression (p < 0.05). CD44 knockdown in BV2 cells ablated TSG-6-ORF-EV mediated nitrite release, IL1β downregulation, and phagocytosis with TLR4 agonists. Our results revealed that under cytokine stimulation, the EV portion of ASC-CCM becomes enriched with TSG-6. Overexpressing TSG-6 in ASC leads to an increased concentration of TSG-6 in sEVs. This enriched EV fraction, containing TSG-6, regulates microglial dynamics through a feedback loop with CD44. EV-associated TSG-6 can influence immune cell behavior and signaling, mitigating excessive inflammation or immune dysfunction. Graphical Abstract Exosomal TSG-6 affects microglial activity This study examines TNF-Stimulated Gene-6 (TSG-6), a bioactive protein from mesenchymal stem cells that segregates into the small extracellular vesicle portion of the secretome and influences microglia behavior, reducing inflammation. Additionally, it highlights CD44’s role in mediating these effects and suggests that TSG-6-enriched exosomes suppress TLR signaling to regulate phagocytosis and inflammation.