The mammalian Cutl1 gene codes for the CCAAT displacement protein (CDP), which has been implicated as a transcriptional repressor in diverse processes such as terminal differentiation, cell cycle progression, and the control of nuclear matrix attachment regions. To investigate the in vivo function of Cutl1, we have replaced the C-terminal Cut repeat 3 and homeodomain exons with an in-frame lacZ gene by targeted mutagenesis in the mouse. The CDP-lacZ fusion protein is retained in the cytoplasm and fails to repress gene transcription, indicating that the Cutl1 lacZ allele corresponds to a null mutation. Cutl1 mutant mice on inbred genetic backgrounds are born at Mendelian frequency, but die shortly after birth because of retarded differentiation of the lung epithelia, which indicates an essential role of CDP in lung maturation. A less pronounced delay in lung development allows Cutl1 mutant mice on an outbred background to survive beyond birth. These mice are growth-retarded and develop an abnormal pelage because of disrupted hair follicle morphogenesis. The inner root sheath (IRS) is reduced, and the transcription of Sonic hedgehog and IRS-specific genes is deregulated in Cutl1 mutant hair follicles, consistent with the specific expression of Cutl1 in the progenitors and cell lineages of the IRS. These data implicate CDP in cell-lineage specification during hair follicle morphogenesis, which resembles the role of the related Cut protein in specifying cell fates during Drosophila development.[Key Words: CCAAT displacement protein; Cux; Cutl1; lung; hair follicle development] The CCAAT displacement protein (CDP) was discovered as a sea urchin transcription factor that restricts expression of the sperm H2B gene to spermatocytes by binding to the CCAAT promoter element in somatic tissues and thereby preventing access of transcriptional activators to the H2B promoter (Barberis et al. 1987). The human CDP (Superti-Furga et al. 1988) was next shown to act as a repressor of the myelomonocytic gp91 phox gene (Skalnik et al. 1991) and, upon biochemical purification, was identified as a homolog of the Drosophila homeodomain protein Cut (Neufeld et al. 1992). CDP, which is also known as Cux1 (Cut homeobox-1), and its related Cux2 protein were subsequently isolated from several different vertebrate species (for review, see Nepveu 2001). The Drosophila Cut protein and its vertebrate homologs share a conserved coiled-coil region at the N terminus, three internal 60-amino-acid repeats (known as Cut repeats), and a divergent homeodomain located near the C terminus ( Fig. 1B; Blochlinger et al. 1988;Neufeld et al. 1992). The mammalian CDP/Cux1 locus is large and complex, giving rise to at least six different splice products as a result of alternative transcription initiation, splicing, and polyadenylation Lievens et al. 1997;Zeng et al. 2000). One of these splice products corresponds to the nuclear protein CASP (CDP alternative splice product), which shares with CDP only the N-terminal coiled-coil sequences ( Fig. 1B; Lievens et a...