Right, but these are industrial monitors. They are designed to work, without intervention (except minor adjustment), in arcade cabinets, just like CRT monitors, and not necessarily MAME, just like CRT monitors.
Arcade LCD monitors should scale up the display if the signal being sent to it is supported.
If the blue VGA cable is being used (and maybe it is) then I agree with you that the PC should always send the native monitor resolution and size the image before the monitor sees it.
If the monitor is acting as an RGB arcade monitor, then the arcade monitor should be doing all of the scaling to native resolution.
If the monitor is connected as RGB and MAME is sending a signal that is not supported by the monitor, then it is MAME's fault this is occurring; MAME should pick a better resolution to send. That can/should be done if this is the case.
If the monitor is connected via RGB and MAME is sending the proper signal for that game, then that signal is not supported by that monitor, and the ArcadeVGA should be replaced with a normal card and the blue VGA cable should be used.
The proper test/proof would be to connect the monitor to an actual MK board with RGB and observe the results. If that display is good then MAME is at fault. If the display is the same (shrunken) then the monitor does not support something about that signal and VGA should be utilized.
AppleKid's response should be heeded.