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 stand-alone firms more than in comparable group-affiliated firms.  Response to the reform was more subdued in group firms with better access to the internal labor market (ILM), suggesting that ILMs mitigate the impact of labor market frictions. We then show that group affiliation became less pervasive following the reform, in line with claims that labor market frictions shape organizations. Our results are unlikely to be driven by groups' internal capital markets or Spain's post-crisis economic recovery.