Let me just say that I CAN read music. I learned with the trumpet which is one note at a time and that's no problem. It's a bit harder to read standard music on the guitar because of the step differences on each string of the guitar. It's just not like a piano where you can go up and down the keyboard and hit the right notes with certain finger patterns that are built into memory--at least it's not as easy. The closest thing to this on the guitar would be power chords, and anyone could CERTAINLY do THAT from standard sheet music.
With a very difficult piece, I can see where someone with the knowledge of sheet music could appear to come out on top. I mean, it's like reading The Night Before Christmas VS memorizing it. Reading it would take less preparation, but some of the performance would be missing vs. the memorized version. The book (or the music, in this case) sits between you and those you are trying to reach like a wall. The sheet music is getting most of your attention, not your audience. It's impersonal. The benefit to playing by ear is that I will have it memorized as soon as I am able to play it (usually about 5 mins after I have listened to it once or twice), and I can pay it verbatim OR begin adding my personal touch to it immediately, IF I so choose. I can also play it if I have forgotten my sheet music at home. If I tried to memorize it from the sheet music, it would be a much more challenging experiece, because the sheet music keeps you from really analzying the patterns of the song. It does your thinking for you.
To each his own. But for me, a big part of internalizing the music is understanding the movements and patterns of the song, not reading them off the page. It also helps you to form a better connection with your audience.
I see bands jamming on stage with music in front of them sometimes and I (and I will admit that this is VERY biased) think immediately that they are amateurish or unpracticed. It's impressive that they can read the music, but they have little to no connection with their audience and it just feels...wrong somehow.
I was going to let this post go, but the last two posts were interesting.
Buck, nice points on both sides of the argument. I've seen you work and I know you have a great ear. It's part of the reason I've always been so impressed with you musically.
Pstl, orchestras sound different because of their director. That's the guy who is paid to think for the musicians who can only read and regurgitate music.

Sheet music is necessary in a large group environment because individuality is not prized (and it just can't be or else it would sound like mud). In a 3-5 person band environment, individuality and creativity are necessities, because you are filling large spacial gaps. The band usually then decides which things are cohesive for the song and which things need to go.
I can tell who has an ear and who doesn't by how well they recognize and can correct mistakes in their playing on the fly. My main thought when I was talking about this was writing. I've never had a good experience writing with someone without an ear.
Here are some quick examples--If I strum a chord, they have to watch where my hands are on the neck. If I add a variation on a chord, they need to see it with my fingers on the neck. If I choose to change a note in the chord structure of the song, they have difficulty leading over it because they have memorized certain scales and cannot step out of them by listening to the rhythm guitar part. If someone is playing a part with single notes that they have come up with, it's hard for them to put the rhythm chords behind it. I can go on. It has little to do with the person's attitude or work ethic. All this to simply say that people with a good ear are much easier to work with.
I'm sorry if this is hurtful to some. It's not my intent to be this way. I respect the work you put in learning to read sheet music and following the orders of band directors! It takes humility! There is hope for those who don't play by ear. They can certainly be extremely successful musicians! They can certainly recreate others work VERY WELL! But in the creative rock songwriting world, I think they would certainly struggle when writing music with their bands.
I got away from organized music because of music teachers. The ones I had were moody, uninspiring, and mediocre musicians. Maybe my feelings derive from those experiences, and I just needed to find the right teacher. I'm older now and I just don't feel like putting in the work to "learn" something I can already do naturally.