Employment Protection and Organizational Structure

We study how business groups are affected by changes in employment protection. A 2012 reform lowering dismissal costs in Spain stimulated employment growth in standalone firms significantly more than in comparable group-affiliated firms. Response to the reform was most muted in group firms with better access to the internal labor market (ILM), e.g. due to geographic proximity to affiliates, suggesting that ILMs partly insulate groups from labor market frictions. We then provide causal evidence that group affiliation became less pervasive in Spain following the reform, in line with claims that labor market frictions shape organizations, favoring the emergence of groups.