This paper studies the effect of country employment regulations on the formation of corporate groups in Europe. While employment regulations in some European countries impose substantial constraints on external labor markets, these regulations do not apply to internal labor markets of corporate groups. Using a comprehensive firm-level dataset covering 15 West European countries, we study the strategic response of firms to increased employment regulations. We document the presence of a specific mechanism through which regulations affect corporate groups: internal labor markets. We find that the propensity of firms to be affiliated with groups is larger where country regulations and industry turnover are jointly high. This result is especially strong for smaller firms, which do not have their own internal labor market, and for affiliates of large and diversified groups. We complement our findings with direct evidence on managerial mobility, and show that internal mobility becomes more likely than external m...