No. That's the strange part. I am not synching the phone.
I haven't physically synced my contact list with Outlook in over 6 months. And my Outlook is not set-up to wireless sync with Outlook either.
It appears this is not unusual. Quickly searched Google; others have had the same issue:
Contact Photo shrinks back to thumbnail - MacRumors Forums
Edit Update: Apparently the Image issue is caused by Google! If you sync your contacts with your Google account this is what's taking place:
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Unfortunately, we can't sync photos larger than the thumbnail size; it's a hard limit in the protocol which we have to obey (as does the iPhone's implementation). We also can't be sure we'll never stomp over high-res photos on the phone with the thumbnails, because if you get into a state where you need a full resynchronization to recover, we need to send the phone everything.
SNOAB! Well that's pretty cruddy. There should be certain parameters set with Google for cross platform information syncing if they know one of the parameters is going to cause problems with other devices.
This isn't a problem on Android phones either. The contact picture displays just fine and in full resolution.
As Google has not or rather chooses not (I guess they want another reason for you to "upgrade" to an Android) to provide a solution for this problem, there are two workarounds:
(1) Change the contact sync default account to iCloud (for those you who have iOS 5.0 > installed, it's free).
(2) The only workaround without buying apps or syncing elsewhere:
1) Create a new contact on your iPhone, using the exact same name as you Exchange contact.
2) If you did it right, iPhone will automatically create a Unified contact card.
3) Choose a hi-res picture for your Unified contact. If you want custom ringtones, etc, select them here too.
That way you don't have to deal with duplicate contacts (when you do this, only one card show up on all contacts), and iPhone will choose your Unified card picture over the low-res Google one.
You need to do this by hand, but it's better than nothing. And it works...
There are two work arounds:
Guess which option I chose?