I think it's just that the hat looks small on him, and could stand to be a bit bigger. Looking at the OVA again, the hat is as big as the rest of his face!
But I know what you are saying. The sprite hat almost looks like a porkpie hat than a big Australian outback cowboy hat.
Just making it like 10-20ish% wider and a hair taller would do it. Not quite Pharrell at the Grammys big, but more like Crocodile Dundee.
Just in my opinion, the Hat doesn't look like it's apart of Knuckles, it looks more like Knuckles... like just the hat is a small detail. I don't know.