Recently, a significant amount of effort has been dedicated to understanding factors that influence the functionality of bio-electronic sensors and to development of novel coating technologies for modifying biosensor surfaces. Due to its well-known biocompatibility, alginate hydrogel (HG) has been used as a coating material on neural electrodes for promoting intimate cellular integration, providing a scaffold for local drug delivery, and creating a mechanical buffer between hard electrodes and the soft tissues of the central nervous system. However, neural signal recordings using HG-coated electrodes in animal models are still poorly evaluated. Here, we investigated the effect of the proximity of source neurons around the electrode sites using HG coatings with various thicknesses deposited on microfabricated electrodes, implanted in auditory cortex of guinea pigs. We also evaluated the role of the conducting polymer poly(3,4-ethylenedioxythiophene) (PEDOT) in improving the recording functionality of the HG-coated neural electrodes. A significant loss in recording functionality was observed with thicker HG coatings, as determined by the number of clearly detectable units (30% with 80 microm thick coatings) and average signal-to-noise ratios (3.91 with 80 microm thick coatings). However, deposition of the conducting polymer PEDOT on the electrode sites restored the lost functionality of the electrodes caused by the HG coatings (30 microm). These conducting polymer/HG coatings have the potential to improve long-term performance of the neural electrodes not only by improving the electrode biocompatibility but also by facilitating more efficient signal transmission.