Try each of the following steps in order until the issue is resolved: In the Word Merge Wizard:

1.  Click Edit Merge Document, remove the image, then re-add it
2.  In the Create Merge Documents section, click on the document that contains the image to select it, then click the Up Arrow button until it is the first document in the merge
3.  If the resulting Merge Document shows the document as being in Compatibility Mode AND a new blank Word document shows as being in Compatibility Mode, then complete the following:
  • Click Start, Run, type regedit and click OK
  • Select My Computer
  • Click Edit, Find
  • Type the word CompatMode and click Find Next
  • It should find the first instance in:  HKEY_CURRENT_USER\Software\Microsoft\Office\12.0\Word\Options
  • Delete the CompatMode entry
  • Click Find Next once again
  • It should find a second instance in:  HKEY_LOCAL_MACHINE\SOFTWARE\Microsoft\Office\12.0\ User Settings\{B8F49D5A-E0DF-465C-9EF0-AF2F95944228}\Create\Software\Microsoft\Office\12.0\Word\Options
     (NOTE: The string in {} in your HKEY_LOCAL_MACHINE key above may be different)
  • Delete that CompatMode entry also
  • Exit the Registry
Word 2007 should open in its native XML mode.
Note : Incorrect changes to registry settings can cause serious system problems that may be irreversible without reinstallation of the operating system. You must back up your registry before making any registry changes. We are not responsible for damage resulting from incorrect use of the Registry Editor.