Defensive gives them a bonus to defend and Aggressive gives them a bonus to hit. You can also specify a Formation for your group. I was wrong. Setting the characters to Defensive, Neutral, or Aggressive is really trivial. Good armor, go aggressive.
Bad armor go defensive.
Formations are even worse. Any formation other than everyone grouped as close together as possible just drastically increased the occurrences of characters obliviously standing around while their companions get wrecked. Using ranged combat seemed to help somewhat, but still characters ended up facing in the wrong direction or shooting at an irrelevant enemy while a stronger one is pummeling someone. Well, you can pause combat, I happily discovered. I was wrong.