Though corporate raiders and financiers have long extolled the virtues of debt as a way to rein in free-spending managers, a less enthusiastic group has continued to question the wisdom of the debt revolution and its effects on long-term corporate value.

A recent study shows that when companies take on too much debt, their investment policies become distorted: They begin to favor divisions that churn out cash over those that are geared toward potentially high-value, long-term returns.

Professor Anil Shivdasani and doctoral candidate Urs Peyer of the Kenan-Flagler Business School, the University of North Carolina at Chapel Hill, investigated investment patterns at 22 multidivisional companies that underwent leveraged recapitalizations between 1982 and 1994. (The number of divisions at these 22 companies varied over the study period from 176 to 233 due to acquisitions and divestitures.) The researchers focused on divisional investments during the three years before and after an increase in debt, hoping to determine how the increased debt loads altered management's investment policies. (The study, "Leverage and Internal Capital Markets: Evidence From Leveraged Recapitalizations,"...