I don't know. I personally don't care for either of these. The first, as
you say, is very restrictive, but I find the second to be that way as well.
Take your example. The game has you "wisely retreat" from the dragon. But
what if you don't WANT to be wise? What if you want to be stupid and see
what happens if you stand around and let yourself get killed? For me,
being forced to retreat gives the impression that you don't have complete
control over your character. You can't make him do whatever you want him
to. Thus, you don't feel that you yourself ARE that character. The
connection is lost.