Drosophila transcription factor cubitus interruptus (Ci) and its co-activator CRE (cAMP response element)-binding protein (CBP) activate a group of target genes on the anterior-posterior border in response to hedgehog protein (Hh) signaling. In the anterior region, in contrast, the carboxyl-truncated form of Ci generated by protein processing represses Hh expression. In vertebrates, three Ci-related transcription factors (glioblastoma gene products (GLIs) 1, 2, and 3) were identified, but their functional difference in Hh signal transduction is unknown. Here, we report distinct roles for GLI1 and GLI3 in Sonic hedgehog (Shh) signaling. GLI3 containing both repression and activation domains acts both as an activator and a repressor, as does Ci, whereas GLI1 contains only the activation domain. Consistent with this, GLI3, but not GLI1, is processed to generate the repressor form. Transcriptional co-activator CBP binds to GLI3, but not to GLI1. The trans-activating capacity of GLI3 is positively and negatively regulated by Shh and cAMP-dependent protein kinase, respectively, through a specific region of GLI3, which contains the CBP-binding domain and the phosphorylation sites of cAMP-dependent protein kinase. GLI3 directly binds to the Gli1 promoter and induces Gli1 transcription in response to Shh. Thus, GLI3 may act as a mediator of Shh signaling in the activation of the target gene Gli1.