you cannot create a AVCHD or a Blu-Ray without the black matte bars. For a 720p movie the video has to be 1280 x 720. So you cannot remove the matte bars as they have to be added or the vertical resolution will not be 720 it would be 546 so not AVCHD or Blu-Ray compliant. It also does not make the image any smaller by adding them. That's impossible unless your monitor is screwing up the aspect ratio. The image will look the same size whether it has the bars or not.

EDIT: Harmy beat me to it