I appreciate the fact that armies, be they merc or regular, are just one of many tools in the game at your disposal that can bring victory, but I find the way combat works at the moment to be lacking. I don't think that the size of armies, be it 4, 6, 8, or 10 men in a unit, is a problem, since it fits with the relative scale of the maps. I have run around with 10+ merc knights, and it feels like a suitably large powerful force. I think the problem lies more with what one can actually do during combat.
At the moment, combat is determined by numbers and unit composition. So if you have the better unit composition and enough numbers, you have pretty much won the battle before it even started. Of course the fact that one has the numbers and the better unit composition means that you followed a good strategy, which is a good thing , but it would be more exciting if one's actual actions during combat could also play a large role in the outcome of the battle.
There are two changes that I feel would bring combat to a whole new tactical level, if they were to be implemented:
1) A melee unit attacking an enemy unit should stand next to it when fighting, and not on top of it.
2) Infantry should not be able to move through enemy units. Mounted units can move through enemy units, although slowed and damaged, but pikemen can block them.
Firstly, at the moment all melee units just clump up on top of each other when fighting, making selecting and manoeuvring of individual units in the thick of things a nightmare. It also makes it difficult to follow the health of individual units. By making fighting units stand next to each other and not able to move through each other, a natural battle line would form between the two forces (true to medieval warfare). For the first time then one could "force" a certain orientation of the enemy armies and subsequently exploit it. For example two infantry forces engaging each other would form a battle line, allowing one to flank the enemy units and purposefully attack their exposed rear. A larger force could surround a smaller force. The game states that attacking from the side or rear of units gives a bonus (which is great), but this is impossible to do when units are clumped up, because one can not even clearly see which way a unit is facing.
By making it impossible for infantry to move through enemy units, one can have infantry screen archers at the back, effectively protecting them from frontal assaults. Mounted units (especially knights with their high armour points) would still be able to break through this defensive line to engage the archers, but at a cost (slowed and damaged). I would change the Defensive Formation skill of pikemen so that it allows pikemen to stop mounted units in their tracks, forcing them to find a different avenue of attack. The slowing/damaging effect of Defensive Formation could then be given in differing degrees to all other infantry by default, which would encourage one to circumvent infantry with cavalry, instead of busting through them when one wants to engage something behind the infantry.
These changes would actually make terrain important. A smaller force could keep a larger force from crossing a choke point like a bridge, by employing men-at-arms, pikemen and bowmen in a sound formation. Currently nothing will stop the larger force from just marching over the bridge and decimating the smaller force. Bowmen would become more important in weakening defensive positions (entrenched men-at-arms/pikemen). On open terrain, mounted units would become more powerful, because it would be more difficult for infantry and pikemen to block of all avenues of attack. The positioning of your army would become just as important as your unit composition.
These are all tactical considerations that are largely irrelevant with the current form of combat. If the above changes were to be implemented, I think combat itself would become much more satisfying and challenging.
PS: I think it would be better to keep it so that all your units can still move through your own units, since changing that would just create needless headaches when positioning your forces.