I think that it should work something like this. you knock out the hero by bringing his health down to 0 and it goes to the reward screen. then during the reward screen there would be a small chance that it would say that you have crippled the enemy hero and that he has asked for your mercy.
If you spare him then he would join your side and fight for your cause after 100 days of rest in your capital city. (after all he is crippled)
He would get to keep all of the equipment that was on him and his upkeep would be equal to what you would normally pay one of your hero's that was at the same level.
If however you choose not to spare him then he would die and you would get to loot 1 epic quality item from his body, you would then be given a box with a list of 5 random items to choose from. The item should be of a slightly higher quality than what he would have had on him if you had let him live
what do you think about that ?