About balancing items In the mods I have played I have noticed the following:
1.- Modders use to favor certain factions or units above others, their armor, weapons and horses are much better and the player experience usually is heavily influenced by this. However this is a cheaty way to compensate for the lack of proper AI and how bad are skills like leadership and tactics implemented.
2.- If there is something like a logical system to reflect the different weapons capabilities, it is destroyed from the moment a modder starts to add elite units, the elite of the elite units, and the cream of the elite of the elites.... with their respective bad ass equipment.
3.- The bonus to damage from proficiencies and power (strike, draw, throw), prevents the system to work because with enough bonus any weapon can beat any armor. But sometimes, some units cannot be damaged due to too much armor, or too low enemy weapon damages. The answer to this is of course giving enough bonus damage to every unit which leads to mods where armor is just for decoration. Being killed in one hit or in two hits, that's the choice. Still it's better than invincible player or ridiculously unbalanced units.
In the end, the player has always to resort to spam those uber elites, and the modders have to increase party size and the ratio of elites in AI parties to avoid easy and boring gameplay. This is a never ending cycle because players will find a way to use those elites in their favor, either getting money from their equipment, selling them to slavers, or converting them to their cause.
My advise is:
Design a complete system and stick to it. The lowest unit tiers should be useful and the highest ones should be within rational parameters. Take into account the bonuses and the reward equipment when designing the system. Find a way to prevent the player to aquire high tier armor and weapons until the late game, and then give him different challenges of a different type like kingdom management or relations. Don't steal his hard work gains making his equipment obsolete. This should be enough for fun playing.
When I played TLD the thing that annoyed me the most was the small maps with annoying borders and obstacles. It was more fun playing evil because to beat the good factions was a real challenge. Morale wasn't a problem because I alternated using a small cavalry pary, and a huge orc spam. When morale and food were depleted I gave them to another lord.
I think there was a system which was used in 1257 AD, bows damage is minimal, shield are high resistance low hit points etc... That system was the best compromise in my humble opinion.