That engine seems to have a lot of problems with modern ATI cards especially. I get low framerates with shadows, and if I turn AA on the screen just goes completely black.
I actually tried the compatability thing, the game would crash upon start-up.
the biggest issue when running on Windows 7 were
horrendous graphical errors. the texture were literally falling apart as I moved around. particularly in outdoor areas. Indoor areas were okay for the most part, the occasional messed up wall here, a broken texture there.
when you went outside into a wide open space though, oh man it was a seizure enducing nightmare. the sky in particular would flash uncontrollably, spasm sending geometric lines everywhere, I'd take one step and all the basic wire-frames of the environment would become visible.
it's very hard to explain, but imagine that some of the world was still intact while other parts would flash to colored versions of their wire-frame base.
I don't what to do now, so I uninstalled the game and am reinstalling it, the sheer volume of graphical errors leads me to believe (I hope) that maybe the game didn't install properly, and if nothing else the game might be
a little more visually stable. Crashing did go down though, but it happened on occassion.
I also got those screen minimizings upon cutscenes, the section where you're leaving Taris and you have to shoot down sith fighters was a particularly nightmarish part for me since the game would minimize on every cutscene, thankfully enough persistance got me through it.
worst comes to worst, I lose ten dollars

I'd really rather that not be the case I love Kotor, but it is what it is.