Unfortunately, none of the Way of the Samurai games have ever really fully realized this idea, often feeling too constrained and even bland enough to really be something special. Way of the Samurai 3 is no different, and despite the franchise's jump to the PlayStation 3 and Xbox 360, there's nothing really new here to help remedy the series' faults.
As I mentioned, you can do pretty much whatever you want. When you talk to someone, you can almost always choose to fight them mid-conversation, regardless of who they are. It seems that you can kill anyone in the game outside of children, and generally speaking, once they're dead, they're dead for the remainder of the game. However, certain characters will simply be replaced by another, doing exactly the same thing, like the recruiter for the Fujimori clan. If you pretend like you want to sign up for their army and kill the guy instead, you'll be able to come right back like nothing ever happened and a new guy will have taken his place.
On the other hand, if you go to speak to the leader of the Ouka clan and kill him and his compatriots, they'll stay dead and you can then become their leader. It's cool that this works, but being their leader doesn't really net you all that much aside from people who bow every time they see you.
Things like this are a nice touch, but the world is simply too small to allow for lots of exploration. There are really only eight places to go, and they're all easily explored in a short period of time. There's no wandering of the countryside, looking for encampments that you've never seen before or anything of that sort. Really, for a game that aims to allow you to play it however you want, there's not enough of a sandbox here to really build a castle.
There are mechanical issues here as well. Some tasks will have you do something as seemingly simple as hunt down a thief and punish him a bit by roughing him up. Even if you're in a place where you're essentially helping the village, if you're chasing around a thief with your weapon out, the guards will come after you and those people will then begin to become afraid of you. Were you able to keep the guy cornered in a dark alley this would be fine, but anyone who's unarmed will run wildly around the city and make this a near impossibility.
If you choose to stick to simpler and less violent tasks, like finding things for people or delivering messages, then you simply become an errand boy and your sword will just be calling for blood. Sadly, you can only have one active task at a time, so you can't just pile on a bunch of things or people to find and complete them at your leisure when you come across them.
Combat too is not as refined as it could be. Each weapon has an attack and defense rating, and if your defense rating is too low compared to an enemy's attack rating, you won't really be able to block his attacks. Since all you do is hold the block button (or tap it to parry), that basically means it's a numbers game rather than being as skilled-based as it should be.
Now, while there are problems in most every mechanic of the game, that doesn't mean it's entirely without merit. Like I said, the design idea is great, and even as limited as it is, it can be fun to just mess around and see what consequences you can cause, good or bad. Again though, given the limited amount of places to go and see (and therein people to talk to), you'll find that you'll rather quickly see a lot of what there is to see.