It's better to kill him. You'll recieve the same reputation bonus (+2) and the same experience bonus for completing the quest (~20,000). You'll also get the extra experience for killing his buddies and he will drop what will likely be one of the most powerful items you've seen at that point. The item is random, but one time I got a very good bow and another time I got some mithril plate mail.
Finally, you will recieve the personal satisfaction of having kicked an evil, murderous demon back to hell where he belongs. Good heroes don't negotiate with demons. They kill them!
As for how to kill him: he doesn't leave his room and he is weak to poision. So, exit the room, drop 2-3 scorpion traps, and kill his buddies. Then go back into the room and drop 3 more scorpion traps. The scorpions will be closer to him and therefore he will hellspike them instead of you. While he is killing the scorpions, shoot him full of poisioned arrows; 5-10 hits should do it. If you can shoot him quickly, you won't need the scorpion traps, since he won't be able to do anything while poisioned. Also, his physical attack is rather weak, so it shouldn't be hard to take him out with a frost weapon if you prefer.
Enjoy,
-Mike