If it's hanging loose, then skin can really get pinched in it. The prong collars aren't meant to actually *pinch*, but if they're too loose they will. Also things can get stuck in a loose collar of any kind, a prong just happens to have more places for things to get stuck in (things as in sticks, paws, etc).
They should fit fairly high on the neck and snug, but not tight. If you can see prong marks from your dog just standing in one (unleashed, just the collar) it's too tight. For the most control it goes right behind their ears, but I typically have it lower down when I use one.
Someone mentioned using a backup collar, too, and that's a very important point. I use a fine choke chain and hook the prong and the flat collar together with it, and attach the leash to the two rings of the chain and to the ring on the prong. It's kind of hard to describe. If you have a quick release prong collar this is even more important. For the record, if you use a halter (which I advise against in most cases, though they too have their uses), you also should be using a backup collar AND a backup lead, so that if the dog hits the end of the leash hooked up to the headcollar you can just let go and reduce the risk of injury (hanging on to the leash attached to the flat collar, though).