In the Fe–SiO2 granular system the effects of oxidation and abnormal grain growth on the magnetic behavior are significant. As film thickness is reduced a larger fraction of Fe grains intersect the free surface and are prone to oxidation even in good vacuum conditions. Films coated with protective SiO2 layers were found to be unaffected by oxidation. The presence of a surface during annealing also affects the microstructural evolution. Transmission electron microscopy observations revealed a bimodal distribution of Fe grain sizes in uncoated films due to grain merger assisted by surface diffusion. This bimodal distribution of Fe grain sizes is associated with a coercivity (Hc) vs vol. % Fe curve containing two peaks. By contrast, SiO2 coated films exhibited a uniform microstructure without unusually large grains and a smoother Hc vs vol. % Fe curve with a well defined maximum. Room temperature coercivities of ∼1000 Oe can be routinely achieved in Fe–SiO2 granular films as thin as 10 nm. X-ray photoelectron spectroscopy studies showed evidence for the chemical interaction between Fe and SiO2 in SiO2/Fe/SiO2 trilayer model film samples. © 1999 American Institute of Physics.