This message often indicates that the EXE file is corrupt. Do Start / Run /
SFC and extract a new copy of the file from the Windows installation CD.
--
Jeff Richards
MS MVP W95/W98

That is generally an indication that the file (defrag.exe) is corrupt so
I would try replacing it.

It is a standard W98 file that you can extract from your CD to the
system folder using sfc.

Run sfc.exe and select the "extract one file..." option.  Type in the
complete name of the missing file you want to restore or use the browse
button for a file replacement.  Click start and in the resulting window,
browse to the location of the folder containing the W98 .cab files
(either the hard drive or CDRom drive).  If the information in the "save
in" box is wrong, use the browse button to show where the file is to be
restored to.  Click OK and if appropriate, on the resulting screen, show
the location where the file being replaced is to be backed up to.  Click
OK or skip as appropriate.  Restart your computer and the file
replacement will occur during the boot process.

If you are going to use sfc.exe for other than the extract option, I
highly recommend that you first read the article here:
http://home.satx.rr.com/badour/html/using_sfc.html