Understanding Federated Learning Through the Lens of Mechanism Design: The Role of Data Heterogeneity

Abstract

Federated learning (FL) requires effective incentive mechanisms to motivate data sharing and prevent strategic free-riding. Recent FL mechanisms such as the Shapley value mechanism M^Shap guarantee reciprocal fairness for agents. However, a complete analysis of how such mechanisms impact social optimality and individual rationality under realistic, standalone outside options remains unknown. In this paper, we address this gap by adapting the classical Externality mechanism M^E to the federated learning setting. We conduct a comparison of M^Shap and M^E across three dimensions: social optimality, individual rationality, and fairness/reciprocity. First, we establish that M^Shap generally does not maximize social welfare because its marginal incentives drive agents to over-contribute resources, while M^E maximizes social welfare by design. Second, we evaluate participation incentives through the individual rationality gap when considering agents' outside options as standalone training on their own data. We find that both mechanisms ensure individual rationality in homogeneous settings. We further show that under mild conditions, M^E maintains this guarantee under agent heterogeneity, whereas M^Shap does not. Third, we demonstrate that while M^Shap maintains perfect reciprocity by design, M^E generally does not, and only ensures that individual benefits match Shapley contributions at symmetric equilibria under homogeneity, as it sacrifices individual fairness to maximize collective welfare under heterogeneity. Empirical simulations validate our theoretical findings and illustrate a tradeoff between reciprocal fairness and social efficiency.