Published in The Journal of Finance, Vol. LVIII, no. 5, October 2003, URI: http://www.blackwell-synergy.com/doi/pdf/10.1111/1540-6261.00599.This paper presents the first model where entry deterrence takes place through financial rather than product-market channels. In standard models of the interaction between product and financial markets, a firm’s use of financial instruments deters entry by affecting product market behavior, whereas in our model entry deterrence occurs by affecting the credit market behavior of investors towards entrant firms. We find that in order to deter entry, the claims held on incumbent firms should be sufficiently risky, i.e. equity, in contrast to the standard Brander-Lewis (1986) result that debt deters entry. The model sheds light on the policy debate on the separation of banking as to whether banks should be permitted to hold equity in firms. It also provides an explanation for why venture capitalists hold automatically convertible securities in start-up firms.The first author acknowledges financial support from Ente Luigi Einaudi, Rome and the TMR Network on “The Industrial Organization of Banking and Financial Markets in Europe”.Peer reviewed