The highly conserved transcription factor Grainyhead-like 2 (Grhl2) exhibits a dynamic expression pattern in lung epithelium throughout embryonic development. Using a conditional gene targeting approach to delete Grhl2 in the developing lung epithelium, our results demonstrate that Grhl2 plays multiple roles in lung morphogenesis that are essential for respiratory function. Loss of Grhl2 leads to impaired ciliated cell differentiation and perturbed formation of terminal saccules. Critically, a substantial increase in Sox9-positive distal tip progenitor cells was observed following loss of Grhl2, suggesting that Grhl2 plays an important role in branching morphogenesis. Gene transcription profiling of Grhl2-deficient lung epithelial cells revealed a significant down regulation of Elf5, a member of the Ets family of transcription factors. Furthermore, ChIP and comparative genomic analyzes confirmed that Elf5 is a direct transcriptional target of Grhl2. Taken together, these results support the hypothesis that Grhl2 controls normal lung morphogenesis by tightly regulating the activity of distal tip progenitor cells.