In a nutshell:
Microsoft 16-bit Operating System (DOS, Win 3.x, and Win 95, and Win 98/ME)
allow programs to make direct calls to system hardware devices.
Microsoft 32-bit Operatings systems (Win NT, Win 2000, Win XP) do not allow
programs to make direct calls to system hardware devices.
Compatibility Mode is an Operating System emulator -- the emulator
intercepts hardware calls from a program, makes a call to the hardware
through the NT-based Operating System, intercepts the reply from the
hardware and relays that reply to the program, thereby "fooling" the program
into thinking that it has, in fact, made a direct call to hardware when it
has not.
For further information, try
Help and Support
type in "Compatibility Mode"
Click on the link "Getting older programs to run on Windows XP"
steve