Ok. Basically that small PCB converts the Amiga drive signals so that they can be used with a non - amiga specific drive. However, you cannot just hook up a normal PC drive. The only type of drive that fits on that PCB is the type of drive in the Escom amiga's (when they had no more Chinon / Proper amiga drives) left in stock, but were still producing Amiga's. They work ok for about 99% of amiga software, but your best option is to remove it and the Panasonic drive, and connect an Amiga 500 drive direct onto the a1200 motherboard.
Hope that helps!
Kevin