The aim of this thesis is to analyse how economic transition affected earnings differentials in Eastern European economies. In particular, as the public sector was the sole employer in the pre-transition period, the analysis of public sector pay setting is crucial to understanding how privatisation affected the labour market during the transition. The central idea of the first essay is to develop a theoretical model that explains the pay setting behaviour of the employer in the public sector. We argue that changes in wage differentials unrelated to productivity differentials may arise from changes in the degree of public sector market power during the transition. The second essay estimates public-private sector pay differentials across the entire pay distribution in Serbia from 1995 until 2008 for men and women separately. It demonstrates the importance of a proper measurement of pay to account for differences in the structure of total remuneration between sectors. The economic transition is found adversely to affect public sector pay gap relative to private sector pay at the beginning but public sector wages increase faster than private sector wages in later stages. The essay adopts a number of statistical procedures including a quantile regression approach. The estimates show more negative or less positive (depending on the time interval) public-private sector earnings differentials among high earners than among low earners. The third essay estimates public-private sector pay differentials across the entire pay distribution in Hungary from 1992 until 2003 for men and women separately. The results show an increasing public sector pay 'penalty' at all the percentiles of pay distribution during first years of transition and a decline later on. However, the pay differential is found to vary across the earnings distribution significantly. Particularly, the essay provides striking evidence of public sector pay compression during transition. Whereas the public-private sector pay gap for workers below the median was rather small, the gap was substantial for workers at and above the median over the whole period considered. The three essays are preceded by an overview of the theoretical and empirical literature on public-private sector pay differentials in i) developed market economies and ii) transition economies of Eastern Europe.