Lung development is determined by the coordinated expression of several key genes. Previously, we and others have shown the importance of the sex determining region Y–box 2 (Sox2) gene in lung development. Transgenic expression of Sox2 during lung development resulted in cystic airways, and here we show that modulating the timing of ectopic Sox2 expression in the branching regions of the developing lung results in variable cystic lesions resembling the spectrum of the human congenital disorder congenital cystic adenomatoid malformation (CCAM). Sox2 dominantly differentiated naive epithelial cells into the proximal lineage irrespective of the presence of Fgf10. Sox2 directly induced the expression of Trp63, the master switch toward the basal cell lineage and induced the expression of Gata6, a factor involved in the emergence of bronchoalveolar stem cells. We showed that SOX2 and TRP63 are coexpressed in the lungs of human patients with type II CCAM. The combination of premature differentiation toward the proximal cell lineage and the induction of proliferation resulted in the cyst-like structures. Thus, we show that Sox2 is directly responsible for the emergence of two lung progenitor cells: basal cells by regulating the master gene Trp63 and bronchoalveolar stem cells by regulating Gata6.