Transforming growth factor β (TGF-β) regulates a broad range of biological processes, including cell growth, development, differentiation, and immunity. TGF-β signals through its cell surface receptor serine kinases that phosphorylate Smad2 or Smad3 proteins. Because Smad3 and its partner Smad4 bind to only 4-bp Smad binding elements (SBEs) in DNA, a central question is how specificity of TGF-β-induced transcription is achieved. We show that Smad3 selectively binds to two of the three SBEs in PE2.1, a TGF- β-inducible fragment of the plasminogen activator inhibitor-1 promoter, to mediate TGF-β-induced transcription; moreover, a precise 3-bp spacer between one SBE and the E-box, a binding site for transcription factor μE3 (TFE3), is essential for TGF-β-induced transcription. Whereas an isolated Smad3 MH1 domain binds to TFE3, TGF-β receptor-mediated phosphorylation of full-length Smad3 enhances its binding to TFE3. Together, these studies elucidate an important mechanism for specificity in TGF-β-induced transcription of the plasminogen activator inhibitor-1 gene.