Does quality decrease by heavily reducing wine?
The extended reduction could be destroying or driving off some of the volatile, organic compounds that give the wine its flavor.  Wine can contain literally thousands of aromatic and flavorful chemicals from the specific variety of grape and the winemaking process (see http://www.winegeeks.com/articles/93 for a good article that balances geeky and approachable) and together their flavor is what makes up the "profile" of the wine's flavor.  As you reduce, some of the more temperature-sensitive ones are being driven off, just like how the alcohol in the wine burns off before the water does.  So it's probably the over-reduction that's culpable here, but some flavor loss/change is inevitable with any reduction.

The other factor is dilution.  Adding or removing water from a substance can change the aromatics that your nose picks up as you eat or drink.  Try this: take two glasses of the same wine, chill one in the fridge, and add ice to the other until it reaches about the same temperature.  You'll very likely notice some significant differences in their flavor.

The best solution is to watch your reduction carefully so that it doesn't over-reduce in the first place.  If you want a stronger flavor, you're better off varying the type of wine that you're using.  Fruit-forward wines like Merlot tend to retain their flavor pretty well in reductions.