An in vitro culture system of rabbit tracheal epithelial cells has been developed to study the regulation of differentiation of the respiratory epithelium on the molecular level. At high density in the absence of retinoids these cells become squamous, stratify, and ultimately form cross-linked envelopes. Several factors influence this terminal differentiation: high Ca2+ concentrations and serum factors promote, whereas retinoids and medium conditioned by fibroblasts inhibit this process. Terminal squamous cell differentiation is accompanied by several biochemical changes: the synthesis of proteoglycans is dramatically reduced and the expression of keratin intermediate filaments is altered. Besides the eight major keratins expressed in undifferentiated cells, terminally differentiated cells also express a 48 kDa keratin. The expression of this keratin correlates well with squamous cell differentiation and appears to be under the control of retinoic acid. The level at which these biochemical changes are regulated has yet to be established. Specific retinol- and retinoic acid-binding proteins have been identified in these cells; the correlation between binding and biological activity of retinoids in this system is in agreement with a role for these binding proteins in mediating the action of these agents.