Turns out that this is simpler than it looks, simpler than I thought it
was going to be anyway. Powerful voodoo this for-each-group stuff....
emp.xsl:
<xsl:stylesheet
version="2.0"
xmlns:xsl="http://www.w3.org/1999/XSL/Transform"
<xsl:output indent="yes"/>
<xsl:strip-space elements="*"/>
<xsl:template name="m" match="*|/">
<xsl:param name="c" select="*"/>
<xsl:for-each-group select="$c" group-adjacent="string(@name)">
<xsl:copy>
<xsl:copy-of select="@*"/>
<xsl:call-template name="m">
<xsl:with-param name="c" select="current-group()/*"/>
</xsl:call-template>
</xsl:copy>
</xsl:for-each-group>
</xsl:template>
</xsl:stylesheet>
emp.xml
<employees>
<supervisor name="jimmy">
<supervisor name="bob">
<employee name="grunt_1"/>
</supervisor>
</supervisor>
<supervisor name="jimmy">
<supervisor name="bob">
<employee name="grunt_2"/>
</supervisor>
</supervisor>
<supervisor name="jimmy">
<employee name="grunt_3"/>
</supervisor>
<employee name="grunt_4"/>
<supervisor name="jimmy">
<supervisor name="bob">
<employee name="grunt_5"/>
</supervisor>
</supervisor>
</employees>
$ saxon8 emp.xml emp.xsl
<?xml version="1.0" encoding="UTF-8"?>
<employees>
<supervisor name="jimmy">
<supervisor name="bob">
<employee name="grunt_1"/>
<employee name="grunt_2"/>
</supervisor>
<employee name="grunt_3"/>
</supervisor>
<employee name="grunt_4"/>
<supervisor name="jimmy">
<supervisor name="bob">
<employee name="grunt_5"/>
</supervisor>
</supervisor>
</employees>
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