The cyclotrimerization of acetylene to benzene on a Pd(111) surface has been studied by scanning tunneling microscopy (STM). The formation of benzene becomes visible upon increasing the acetylene coverage at 140 K. Initially, the acetylene molecules adsorb in a (2 x 2) ordered layer, which is compressed into an ordered (root 3 x root 3)R30 degrees structure when more acetylene is added. The cyclotrimerization reaction is observed just before saturation of the (root 3 x root 3)R30 degrees structure and stops when the saturation coverage is reached. Further exposure to acetylene does not result in a reaction, indicating that the cyclotrimerization reaction involves a transient adsorption state, different from that in the (root 3 x root 3)R30 degrees layer. The (root 3 x root 3)R30 degrees layer itself is stable up to 230 K, even when a background pressure of acetylene is present. At 230 K, the root 3 x root 3)R30 degrees layer decays, a process which is related to the isomerization and further decomposition of acetylene. The results are consistent with the available spectroscopic data and indicate that the limited conversion of acetylene to benzene is determined by the relative rates of (root 3 x root 3)R30 degrees domain formation and cyclotrimerization.