Multipotential neural stem cells (NSCs) in the central nervous system (CNS) proliferate indefinitely and give rise to neurons, astrocytes, and oligodendrocytes. As NSCs hold promise for CNS regeneration, it is important to understand how their proliferation and differentiation are controlled. We show here that the expression of sox2 gene, which is essential for the maintenance of NSCs, is regulated by the Gli2 transcription factor, a downstream mediator of sonic hedgehog (Shh) signaling: Gli2 binds to an enhancer that is vital for sox2 expression in telencephalic neuroepithelial (NE) cells, which consist of NSCs and neural precursor cells. Overexpression of a truncated form of Gli2 (Gli2DeltaC) or Gli2-specific short hairpin RNA (Gli2 shRNA) in NE cells in vivo and in vitro inhibits cell proliferation and the expression of Sox2 and other NSC markers, including Hes1, Hes5, Notch1, CD133, and Bmi1. It also induces premature neuronal differentiation in the developing NE cells. In addition, we show evidence that Sox2 expression decreases significantly in the developing neuroepithelium of Gli2-deficient mice. Finally, we demonstrate that coexpression of Gli2DeltaC and Sox2 can rescue the expression of Hes5 and prevent premature neuronal differentiation in NE cells but cannot rescue its proliferation. Thus these data reveal a novel transcriptional cascade, involving Gli2 --> Sox2 --> Hes5, which maintains the undifferentiated state of telencephalic NE cells.