This was taken originally from an interview I did with Co-Optimus (linkie link) about the Co-Op, Orbs and All. It explains the Xbox LIVE co-op mode. Hopefully you'll find this interesting.
Them: In either the local or Xbox LIVE co-op mode, is it possible to use your own character instead of a prefabricated one when joining another player’s game as their henchman?
Me: In both local and Xbox LIVE co-op mode, a player joining your world will join as your henchman and not as his or her own character, because NPCs are designed to react to the henchman as an extension of the hero. Lionhead Studios did test a split A.I. system at one point, but because the hero and henchman are within close proximity of each other most of the time (as they’re both on screen), players found it almost impossible to decipher who an NPC comment was targeting. When thirty people are gathered around the player, there needs to be a combined, single message otherwise things get very confusing, and actively damage the feeling of “heroism”.
While you will not be able to see another player’s character when they are invited into your world as your henchman, joining other players’ worlds in co-op mode is more significant, because it will allow you to not only see their character, but also experience their Albion life as a whole – how NPCs react to their character, the different towns/villages in their world, their character’s family, house, job, etc.
Oh and read the book Orbs and the Multiworld.