I have spent 2 years and $400k developing a new product ( which is
patented and protected and in my name only),my company is about to be
launched, I have approached a successful CEO with broad industry
knowledge,experience and networks. He loves my product and is ready to
give up his well paid $200k position as the CEO of a similar company
to work (unpaid )with me to launch the company.  The company will soon
be worth several million dollars and he has agreed to take equity
instead of salary until funds start flowing.
I am expecting our capital investors to claim around 30-40% of
equity.
My question is what equity should he have and why ?
How can I structure this to suit all parties?

Ideally, you should keep control.

So, determine the maximum that you are prepared to give away and set
aside this sum as equity for the MD, then let him earn it at the rate
of (say) $200k pa until the cash flow becomes sufficiently positive to
fund his salary.

Why? Because this seems to reflect the basis of your agreement with
him, as I understand it.

Of course, he might have other ideas and, therefore, your best bet is
first to ask him to spell out what he thinks is fair and reasonable.

This is always the best strategy!

If you are seeking capital investment from experienced and
professional private investors (whether individuals or venture capital
firms), then as part of their investment they'll want to be actively
involved in selecting or approving the management team. So while it is
excellent that you already have a CEO lined up who you think is
perfect for the job, it would be best not to lock yourself into any
contracts with him specifically before you've discussed and agreed on
it with the investors. (See the relevant part of this reference:
http://www.ey.nl/download/publicatie/Guide_to_producing_a_Business_plan.pdf
)
It is quite likely that given the stake (30-40%) you are trading them
for their capital, that your agreement with them will include
provisions as to the remuneration of management and employees.

There are a number of professionals you can (and probably should)
consult before drawing up an agreement with your management and
investors, including a venture lawyer and non-investing business
startup advisors. Your capital investors will also have their own
advice on what your CEO is worth and how they should be paid.

Further info:

As you are seeking private equity or venture capital you may also be
interested in reading this article on protecting yourself from any
nasty surprises down the track:

http://www.fortune.com/fortune/smallbusiness/articles/0,15114,361385,00.html

A guide on the legal issues and important decisions involved in taking
on private equity or venture capital can be found here:

http://www.vcapital.co.nz/downloads/legaljohnde.pdf