​In November 1936, twelve women met to formulate a plan for establishing a Children's Theater in Terre Haute. Realizing the value of such a movement, this group enthusiastically set out to interest others. Twenty-seven women founded what is known today as the Children's Theater. The first officers were Mrs. Oscar Bauer, President; Mrs. John J. Connolly, Secretary; and Mrs. Will Kivits, Treasurer.

The purpose of the organization was to encourage and develop children's appreciation of and dramatic talent for the theater. The first season's plays were The Wizard of Oz and Treasure Island, both which were directed and produced by Jane Freeman Savage with assistance from Emerolous Van Cleave Reintzes. These plays, presented in the Woodrow Wilson auditorium and in the old Hippodrome Theatre, proved to the founders that a children's theatre could be self-supporting and that the public was interested in the endeavor.

In September 1937, Indiana State Teachers College (now Indiana State University) and the Public School Systems of Terre Haute and Vigo County (now the Vigo County School Corporation) expressed a desire to become affiliated with the organization. Since the aim of The Children's Theatre was to encourage self-expression in children, the founders believed the sponsorship of schools would prove valuable and the proposal for a cooperative association was accepted. The founders retained the privilege of conducting all business connected with the organization and Lillian Decker Masters accepted the position of director. Large casts of children were a trademark of Lillian Masters' fine Children's Theatre Productions (1937-1958). She wrote many of her productions in collaboration with her husband, Dr. Robert Masters.

In October 1964, the members of the Children's Theatre established the Lilith Bauer Scholarship as a living memorial to the founder of the organization.

In June 1977, The Children's Theatre, Indiana State University and Saint Mary-of-the-Woods College formed a significant new alliance. These organizations produced a season of plays and sponsored the Peppermint Stick Players. The Peppermint Stick Players had been founded by the two academic institutions in 1975 to take children's plays to communities in central and southwestern Indiana.

In Celebration of its 50th anniversary season during 1987, Children's Theatre presented Winnie-The-Pooh in May. Directed by Dixie Brown, this production returned Children's Theatre to its original purpose of offering theatre for and by children. Winnie-The-Pooh involved a cast of 46 children. Members and children were involved in all aspects of the production including make-up, props, costumes, and set building.