True - their armor/weapons can be upgraded in the same way as normal non-champion units.  They just can't be "upgraded" with found equipment from quests/goodie huts because they don't have an inventory.

This isn't such a hindrance with Commanders whose main role is support, but it's not so great for assassin/warrior/defenders.  For these you mostly just want high initiative + enough armor to protect against stray missiles; you're not expecting them to do much damage or blocking on their own. For these, I prefer a horse, Aegis robe + leather complement, but with the +init boots instead, +init amulet/belt,  fill out the rest of the item slots with some defensive items like the first aid kit, rations, braided metal belt, or belt of precognition, and a dagger (or Skath claw if you have it) for +3 (or +4) init. For traits, Veteran + Fast + whatever else seems best (probably the +HP, + Defense, or +Dodge traits, but if you're playing a custom faction, +XP traits get the nod.)

The upgrade definition just considers defense, not other factors, so if you gave them +1 defense, they wouldn't "upgrade" to leather.  OTOH, leather boots won't upgrade to soldier's boots, either (since they're not better defense.)  

If you do that though, consider that you're basically obsoleting leather boots (ok, maybe not a *huge* deal, but it will apply to lots of AI units) and giving out another +1 defense item in the period prior to researching leatherworking.  You'd probably have to give them a hefty increase to build cost to make leather boots ever worth even considering (as it is, I already seldom use leather boots.)

Note that chain boots are +2 defense, so there's not a big range to work in (if you go to +2 defense, you're obsoleting chain boots as well.)

You could also go the route of modifying the upgrade definitions in the XML to take +init into account, but that would need to be done for all of the existing AI and "stock" unit definitions (if you care about that), and would not apply to any newly defined custom unit definitions created with the UI.

Heroes never die, and in my current game I've experimented with letting them get injured a lot more. A lot of the time the injuries are not that bad, e.g. I don't really care about -50% poison resistance or -50% cold resistance or -1 physical attack. Some of them are pretty bad though, -25% experience, -25% hit points, -1 hit point for every unit in your army.

It's a lottery, and it's very expensive (and late in the game) to use potions to heal injuries. I think the balance is about right, you can risk your heroes if you want to (and they can remain effective even with a few injuries), however they miss seasons immobilized and healing, and you run the risk they will pick up a really bad injury. So you don't want them to get injured, but you are prepared to risk them sometimes if there's enough to be gained.

Look how weapons' upgrade is done. It calculates SUM of all bonuses and choses the highest value. So make AI compare SUM of Defence, Initiative or other attributes. Thus +1 Defence, +2 Initiative item would be better than just +2 Defence. All this needs testing though.