Darai, King of Sorrow has no clothes on!
I believe in the theory that Klonoa is a boy from the real world, and that his dreams represent the life he has had in this world. I'm sure Mr. Yoshisawa was reading about what dreams are while making the game, we can not dream of things we haven't been exposed to.
So that means Klonoa's friends are in fact imaginary friends: Lolo may have been based of a girl he met who was in love with klonoa, Popka was her dog, Leorina may have been a bully who in fact felt very depressed, King of Sorrow may have been a brother of Klonoa, and the pac-man on his hat means that he is a fan of Namco (or should I say he was?).
Nevertheless like with real dreams it all depends on your interpretation of the game. The first game tried to make you feel like you were Klonoa and the message in the end "Come back to your Phantomile" meant that you shouldn't always live in your dreams, that you have to go out there and face the real world.