1) When you edit the style of RadPanelBarItem, you will see 2 ControlTemplates - PanelBarItemTopLevelTemplate and PanelBarItemSecondLevelTemplate.
If you edit them you might end up with the result above.
2) Have your tried setting VerticalAlignment="Top" to the PanelBar. This will make the PanelBar give its items only the space they require.
I'm attaching my test project for further reference. If I haven't understood you correctly, could you please elaborate a little bit more on what you are trying to achieve. I'd be glad to further assist you.
the Telerik team
Do you want to have your say when we set our development plans?
Do you want to know when a feature you care about is added or when a bug fixed?
Telerik Public Issue Tracking
system and vote to affect the priority of the items