There are many ways that this discussion could get complicated. I'll try to keep my input to the point.
To keep it simple: "small" & "LARGE" in English both refer to size. But in the world of Dolby Digital(AC-3) these terms were poor choices for what Dolby was actually trying to create in homes.
Essentially, general rule of thumb is that if your speakers
cannot put out more than 100db at 20hz - set them to "small".
There are several great reasons for not setting your speakers to "LARGE" as specified in Dolby's paper describing what they are doing with AC-3 and how it should all work. It seems that when AC-3 was first being implemented the original thought was (& I am paraphrasing here) "Most people have little speakers that are weak, so we can't have them playing low". What's been the typical rule of thumb as home theater has evolved, however, is that even with what the avg. consumer would consider a full-range tower speaker (which usually isn't full-range BTW, but that's for another discussion) that the speakers set to "small" is still optimal when a subwoofer(s) system is present. Are there cases where this rule can be broken... OF COURSE!.... is it the norm or even remotely common?... Absolutely NOT.
- A great benefit of setting a receiver to "small" is that it will be relieved from performing low-freq bass duties (that it would more than likely struggle at unless it can pull off the performance listed above). Your speakers (and amp) will potentially be freed up to perform louder and cleaner in the highs and mids (which, again, are the signals that Dolby & AC-3 WANTS them to have to perform) without muddying from attempting to go deep, which is what your dedicated subwoofer(s) should be doing for them.
- A drawback of "LARGE" settings is that since bass has the hardest time interacting in a room, multiple sources of low-freq in non-optimal positions can/will cause a number of EQ/wave problems.
Keep in mind that with most bass management systems the 80hz crossover point is NOT a "brick wall". It slopes in both directions. For this reason optimal performance from a speaker should be flat down to 40hz, which many speakers can do. Some can realistically hit 30hz. But it is extremely rare for a speaker to truly go down flat to 20hz and below with tangible volume.
Set to "small" the receiver passes low-freq to the sub while "LARGE" settings on a receiver do NOT filter any frequencies from the mains to the sub. Hopefully we can see where this would be a nasty problem with the wrong gear.
Dolby Labs 5.1 production guidelines (please see section 3.3).
http://www.dolby.com/uploadedFiles/zz-_Shared_Assets/English_PDFs/Professional/L.mn.0002.5.1guide.pdf