We present genetic and biochemical evidence that PAX6 is a key regulator of pancreatic islet hormone gene transcription and is required for normal islet development. In embryos homozygous for a mutant allele of the Pax6 gene, Small eye (Sey(Neu)), the numbers of all four types of endocrine cells in the pancreas are decreased significantly, and islet morphology is abnormal. In the remaining islet cells, hormone production, particularly glucagon production, is markedly reduced because of decreased gene transcription. These effects appear to result from a lack of PAX6 protein in the mutant embryos. Biochemical studies identify wild-type PAX6 protein as the transcription factor that binds to a common element in the glucagon, insulin, and somatostatin promoters, and show that PAX6 transactivates the glucagon and insulin promoters.