The homeobox gene otx2 is a key regulator of positional identity in vertebrates, however its downstream target genes and mechanism of action are not known. We have analyzed otx2 function during formation of the Xenopus cement gland, an organ that expresses otx2. The cement gland forms at early neurula from extreme anterior ectoderm and corresponds to the chin primordium of mammals. Previous studies (Blitz, I. and Cho, K. (1995) Development 121, 993–1004; Pannese, M., Polo, C., Andreazzoli, M., Vignali, R., Kablar, B., Barsacchi, G. and Boncinelli, E. (1995) Development 121, 707–720) showed that misexpressed otx2 could activate cement gland formation. However, it was not clear whether this was a direct effect of otx2 or a secondary consequence of other tissues induced by otx2. In this study we ask whether otx2 activity is spatially and temporally restricted in the ectoderm and whether cement gland-specific genes are direct targets of otx2. In order to control the timing of otx2 activity, we constructed a dexamethasone-inducible otx2 protein (otx2-GR) by fusion with the ligand-binding domain of the glucocorticoid receptor. We conclude first, that regionally restricted factors regulate otx2 activity since otx2-GR is able to activate the cement gland markers XCG and XAG only in ventrolateral ectoderm, and never in the neural plate. Second, we show that temporal responsiveness of the ectoderm to otx2-GR is limited, beginning only at mid-gastrula but continuing as late as tailbud stages. Third, we show that otx2-GR activates expression of the cement gland differentiation marker XCG in the absence of protein synthesis, identifying a direct target of otx2. otx2-GR can also activate expression of the endogenous otx2 gene, defining an autoregulatory loop. Fourth, we show that otx2-GR is sufficient to overcome the inhibitory effects of retinoic acid on cement gland formation, indicating that this effect is caused by failure to express otx2. Corroboratively, we show that otx2 autoactivation is prevented by retinoic acid. Together, these findings suggest that otx2 directly controls cement gland differentiation, and that spatial and temporal modulation of otx2 activity limits cement gland formation to the front of the embryo.