Basement Stairs Area - Stumped! Calling designers, carpenters, drywallers, and artists!?

Have you thought about tile? You could tile the concrete wall and finish the seam between the tile and the drywall with a matching tile liner or molding. You might have to build up a bit of a mortar bed to make that work. Paint the drywall a color to coordinate with the tile. Depending on the kind of tile you use, you could make some framed tile wall hangings to hang on the drywalled area to tie the two surfaces together.