My house rule on defender retreats is that the defender can call a retreat, but only after fighting at least one full round of combat.
Once a retreat is called, one final round of combat will take place in which the attackers fire again, but the defenders do not return fire. After that, the surviving defenders escape.
This keeps defensive retreats from being abused to stall the game indefinitely.
Other caveats:
Defenders must all retreat together to the same territory (except for any planes that were scrambled into the battle, they go back where they came from) - no splitting them up and dispersing to different territories, no withdrawing some of them and keeping others behind.
The destination must be adjacent to the battle zone, it must be under the control of the defender or their allies (if it's a land territory), and it must be free of enemy units (no retreating into a contested zone to reinforce another battle that's going to happen in the same turn).
Retreat cannot be called if there's no eligible territory to escape to.
The only exception to the splitting rule is if two or more allies have units defending the same territory - they each make their own decisions on whether to fight or retreat. So let's say we're in Tobruk, the British attack, the Germans and Italians are defending. Germany decides to retreat to Libya, but Italy wants to stay and fight. On the next round, only the British and Italians will fire, any hits scored by the British can be taken by either the retreating or the remaining force (whichever the Axis player(s) decide), then the Germans are gone and fighting resumes as normal between the British and Italians on the following round.
Or if that's too complicated, simply rule that retreat must be mutually agreed upon by all allies taking part in the battle before it's allowed so they all stay or withdraw as one.
