We have used an in vitro assay to identify sources of retinoic acid (RA) and transgenic mice to identify target domains in the developing forebrain. RA participates in a sequence of events that leads to the establishment of the olfactory pathway. First, the lateral cranial mesoderm activates an RA-inducible transgene in neuroepithelial cells in the olfactory placode and the ventrolateral forebrain. Then, neurons and neurites begin to differentiate in these two regions. Finally, olfactory axons grow specifically into the ventrolateral forebrain and subsequently are limited to the olfactory bulb rudiment. The coordination of these events, perhaps by common signals, implies that retinoid induction and retinoid-activated region-specific transcriptional regulation may help to define a forebrain subdivision and the peripheral neurons that provide its primary innervation.