My original guess was that the video on the produced DVD image was not anamorphic. Anamorphic means that the video is designed to work in 16:9 format and 4:3 format; see Wikipedia's definition for more detail. Actually, the video content is correctly coded.
The problem is that iDVD sets one single bit in the VIDEO_TS file structure incorrectly -- it explicitly tells DVD players not to letterbox. This is explained in great detail on this page.
In the section titled 'A way to simplify things!' on tha tpage, you'll find this link to a Perl script created by Daniel Rogers that fixes the problem. All this script does is copy the entire mounted volume into a new .dmg file that has the bit corrected. It takes about eight minutes on a 1.25 GHz Mac mini with a 3.8 GB DVD .img file.
I kind of hope that the new release of iDVD 6 will fix this, but for those that don't have it, or in case it doesn't, you're in luck.

