"Never, ever think about something else when you should be thinking about the power of incentives."
 -- Charlie Munger

Maybe you've heard this popular myth: A major cause of the financial crisis was boneheaded Wall Street compensation packages unaligned with shareholder interests.

Before I can tell you why that story is so misleading, please ask yourself this question.

Am I an investor, or am I a speculator?
During his recent visit to Fool HQ, business legend John Bogle argued that this is the very first question you must ask yourself.

The distinction is simple but powerful: Investors buy shares of businessesand prosper over time as the company grows profits. Speculators, on the other hand, trade wiggleson a stock chart, in hopes of selling shares at a higher price to other speculators within a few quarters.

Back to the myth
Sadly, shortsighted compensation plans and business strategies arealigned with the time horizons of the vast majority of shareholders. After all, at year-end 2007 (the most recent statistical set), some 80% of all shares were held by financial institutions. And the evidence shows that financial institutions are, by and large, speculators.

Given the explosion of mutual funds, 401(k)s, endowments, and the like, it makes sense that institutional ownership has steadily risen over the years. As institutional ownership has grown, however, the average holding period of stocks has shrunk:

Year

NYSE Turnover

Holding Period

2009 (year-to-date)

141%

9 months

2000

88%

14 months

1990

46%

26 months

1980

36%

33 months

1970

19%

63 months

1960

12%

100 months

Source: NYSE Group Factbook. Turnover = number of shares traded as a percentage of total shares outstanding.

It gets even worse when we look at the overall stock market, according to Bogle. Inclusive of exchange-traded funds, the overall market turned over at 284% in 2007. That means the average holding period for stocks and ETFs was four months!

OK, but how does this speculative frenzy affect you?

Wall Street's very dirty secret
Simply put, when institutional shareholders have a time horizon of four months, they should wantmanagement to pull out the stops right nowto hit quarterly earnings targets. If they're not going to own the stock in five years, why would they concern themselves with the long-term effects of today's business decisions?

Consider the average holding period of these stocks in 2007 -- the year before the volatility-inducing financial meltdown:

Company

Holding Period

Bank of America (NYSE: BAC)

9.4 months

AIG

9.3 months

Citigroup (NYSE: C) Continued...