The contact photos does not need to be on the device. They are embedded into the contact.
This I know.
Whether a full image are shown or not, my guess is, it has to do with dimensions/resolution of image used. Small dimensions/low resolution and they show up in small circles. But if the dimensions and/or resolution is good, full contact images are shown.
This I believe is correct.
As usual, it would be so nice if it was possible to search support.apple.com for things like iOS contact image dimension requirements... but the closets I can get is this:
http://support.apple.com/kb/HT4489
There you can at least see the formats of image files and size in KB supported. But not size required for full contact feature support.