You'll notice the difference in two spells like Reduce Person and Enlarge Person when it comes to projectiles; Enlarge Person has projectiles shrink to their normal size, while with Reduce Person they stay the same size. Pretty much for this exact reason. If he wants to do some more damage with his crossbow, he can look into the Gravity Bow spell. It makes bolts strike as if they were larger. Not ballista bolt large, but if you're playing a home game or something maybe you could make a Greater Gravity Bow spell that makes a crossbow bolt hit as if two or even three times larger.
As to the command word question, yes, it is a standard action to activate a magic item.
Heh... I'd allow it. Just because it's creative and funny... And honestly, if that as far as the mage's optimization and spell "abuse" goes, you should count yourself lucky! XD
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I assume he is using the 'shrink item' spell, and yes it is completely broken... though not for this case.
As noted, command word doesn't work because it would require a standard action. The spell also allows items to return to full size when tossed on to a solid surface, but you could rule that; firing out of a crossbow doesn't count as tossing, the force of the string triggers the effect and the bolt becomes full size and immediately falls to the ground, total inertia is kept constant so the full size bolt is barely moving when it strikes the target and does no more damage than normal, et cetera. Plenty of ways to prevent that usage.
Where it gets really bad is when he decides to start tossing shrunken barrels of acid, alchemist's fire, holy water, et cetera. As the spell is written that should work just fine. Next up is using the 'cloth' form, tying it around a rock, and tossing that to unleash burning bonfires, large sacks of caltrops, a small lake, et cetera.