i don't know exactly how it works, but it widens the stereo field to give a closer effect to real surround than stereo. Why have simulated surround instead of just stereo? It sounds more impressive. Pity that it's not an option in the system, but then again both the DS and PSP sound better (or debatably best) via a good set of headphones or earphones.
PSP sound always seems muffled to me. Maybe an artifact of form over function. That little skinny grille on the front I suppose is where the speakers are. It can certainly get loud, but it's not very crisp. Could also be audio compression to cut down on loading.
That's not where the speakers are. Also, the speakers are just weak in general - nothing to do with loading. Wear headphones to hear how it should sound.
Not all stereo sounds are alike. Surround is probably modified to sound well given the usual placement of the DS speakers to a person's head. Like how some games also have a Headphone option, which is yet another variant of stereo sound.
It would've been possible to get surround sound via headphone via Dolby's Virtual Headphone tech, but it would've been more processor intensive and Sony would have to pay to license the technology.
And speakers are always a weakpoint of pocket tech, especially with such a "hi-fi" device as the PSP. Headphones are the answer.