During development, compartmentalization of an early embryonic structure produces blocks of cells with distinct properties and developmental potentials. The auditory and vestibular components of vertebrate inner ears are derived from defined compartments within the otocyst during embryogenesis. The vestibular apparatus, including three semicircular canals, saccule, utricle, and their associated sensory organs, detects angular and linear acceleration of the head and relays the information through vestibular neurons to vestibular nuclei in the brainstem. How the early developmental events manifest vestibular structures at the molecular level is largely unknown. Here, we show that LMO4, a LIM-domain-only transcriptional regulator, is required for the formation of semicircular canals and their associated sensory cristae. Targeted disruption of Lmo4 resulted in the dysmorphogenesis of the vestibule and in the absence of three semicircular canals, anterior and posterior cristae. In Lmo4-null otocysts, canal outpouches failed to form and cell proliferation was reduced in the dorsolateral region. Expression analysis of the known otic markers showed that Lmo4 is essential for the normal expression of Bmp4, Fgf10, Msx1, Isl1, Gata3, and Dlx5 in the dorsolateral domain of the otocyst, whereas the initial compartmentalization of the otocyst remains unaffected. Our results demonstrate that Lmo4 controls the development of the dorsolateral otocyst into semicircular canals and cristae through two distinct mechanisms: regulating the expression of otic specific genes and stimulating the proliferation of the dorsolateral part of the otocyst.