Two types of human ES-cell-derived otic progenitors are shown to have the ability to differentiate in vitro into hair-cell-like cells and auditory neurons, and to engraft, differentiate and improve auditory-evoked response thresholds when transplanted into an auditory neuropathy model; this indicates that it may be possible to use cell-based therapeutic strategies to recover damaged sensory circuitry in deafness. Auditory neuropathy is a form of hearing loss in which the sensory-hair cells of the inner ear are often relatively unscathed, making cochlear implants alone ineffective as therapy. Rather, it is the next step in the auditory pathway that is impaired by damage sustained by the spiral ganglion neurons, and there are no routine treatments available to counter sensory-neuron loss. This paper reports the generation of ear-cell progenitors from human embryonic stem cells, and shows that these otic progenitor cells can differentiate into functional cells involved in auditory response. Transplant of the otic progenitor cells into chemically damaged gerbil ears restores auditory evoked response in the brainstem, suggesting that this type of procedure, combined with cochlear implants, could form the basis of a cell-based therapy for some types of deafness. Deafness is a condition with a high prevalence worldwide, produced primarily by the loss of the sensory hair cells and their associated spiral ganglion neurons (SGNs). Of all the forms of deafness, auditory neuropathy is of particular concern. This condition, defined primarily by damage to the SGNs with relative preservation of the hair cells1, is responsible for a substantial proportion of patients with hearing impairment2. Although the loss of hair cells can be circumvented partially by a cochlear implant, no routine treatment is available for sensory neuron loss, as poor innervation limits the prospective performance of an implant3. Using stem cells to recover the damaged sensory circuitry is a potential therapeutic strategy. Here we present a protocol to induce differentiation from human embryonic stem cells (hESCs) using signals involved in the initial specification of the otic placode. We obtained two types of otic progenitors able to differentiate in vitro into hair-cell-like cells and auditory neurons that display expected electrophysiological properties. Moreover, when transplanted into an auditory neuropathy model, otic neuroprogenitors engraft, differentiate and significantly improve auditory-evoked response thresholds. These results should stimulate further research into the development of a cell-based therapy for deafness.