Setting the line height in the css did not work for me, but with a bit of tinkering around, I found that setting the rowHeight property in the jquery.dd.js file did fix this problem.
e.g.
//dropdown class
function dd(element, settings) {
var settings = $.extend(true,
{byJson: {data: null, selectedIndex: 0, name: null, size: 0, multiple: false, width: 250},
mainCSS: 'dd',
height: 120, //not using currently
visibleRows: 7,
rowHeight: 100, //HEY STACKOVERFLOW - CHANGE THIS!!!!
It's a bit bodgy as it means you need to know in advance how tall you want your items to be, and presumably it could cause problems if you have several msdropdowns on a page which you want to give different heights.
It solved the problem for now, though.