You are not penalized. Several posters have in fact demonstrated (in game) that you get more experience by not killing everything that moves. So this is a non issue.
The current debate revolves around the concept of double dipping. i.e. getting the quest exp (more than you would by just killing) and then killing the guys.
It doesn't matter which side has the advantage, they should both be the same. It's not really a hard sell, but people seem to hate everyone being treated equally in this thread... :-/
I don't think it's that at all.
"They should both be the same" doesn't negate the problem of "double-dipping" as this thread is about, meaning you complete the quest the "right" way and then kill everyone for more experience points.
The counter-argument is that "double-dipping" shouldn't be a concern for the developers because there's more than one way to play a single-player game like this.
I'm a role-player at heart, which means I will generally complete quests the way I picture the character I'm playing would. If I'm playing an upstanding knight-type character, for instance, I'll try to avoid stealing and murdering to get what I need. It also means that I'm not really concerned with obtaining all the possible experience points the game has to offer.
Another person may prefer to play the game more like a testing ground for their builds and pushing every corner of a character's limitations by getting as much experience as possible and pushing themselves to the absolute limit the game will permit.
Neither way is "wrong," and neither way has an "advantage" over the other because they're both simply ways to play the game how you enjoy it.
The arena uses premade characters with predefined abilities and gear sets, so it's not like the number-cruncher is going to have a statistical advantage in arena PvP (at least not by virtue of having a character that "double-dipped" in the campaign). And in multiplayer, assuming you can import characters into other players' games, if you don't like the fact that someone "double-dips" or it impedes your enjoyment of the game because they're so much more powerful than your character at the same point in the game, then simply don't play with that person. Instead, find someone or a group of someones that enjoys the game the same way you do.
It really is a non-issue for a single player game like this.
If it were a real issue, several viable solutions have been proffered and the developers could easily just flag quest-givers and quest-related NPCs as "indestructible" once their related quest is completed so a player has to choose between slaughtering them or completing the quest the non-violent way. The problem here is, however, that you're forcing a player to play a single player game a certain way, which is inherently a bad design philosophy in this day-and-age.
