Identifying how organismal attributes and environmental change affect lineage diversification is essential to our understanding of biodiversity. With the largest phylogeny yet compiled for grasses, we present an example of a key physiological innovation that promoted high diversification rates. C4 photosynthesis, a complex suite of traits that improves photosynthetic efficiency under conditions of drought, high temperatures, and low atmospheric CO2, has evolved repeatedly in one lineage of grasses and was consistently associated with elevated diversification rates. In most cases there was a significant lag time between the origin of the pathway and subsequent radiations, suggesting that the 'C4 effect' is complex and derives from the interplay of the C4 syndrome with other factors. We also identified comparable radiations occurring during the same time period in C3 Pooid grasses, a diverse, cold-adapted grassland lineage that has never evolved C4 photosynthesis. The mid to late Miocene was an especially important period of both C3 and C4 grass diversification, coincident with the global development of extensive, open biomes in both warm and cool climates. As is likely true for most "key innovations", the C4 effect is context dependent and only relevant within a particular organismal background and when particular ecological opportunities became available.