Abstract: This paper establishes diversified investment models of debt-financed firms aiming aim at maximizing equity value and firm value respectively.After comparing investment decisions under these two different objectives,it analyzes the non-optimization problem resulted from conflicts between equity-holders and debt-holders.The results reveal that,if there is no debt risk before and after diversified investment,those investment decisions maximizing equity value would maximize firm value at the same time.If investment could shift risk free debt to risk debt,equity-holders would over-invest in diversification projects.If there is debt risk before and after diversification,the firm would under-invest in diversification projects.

Key words: debt financing, agency conflicts, diversification, real option.