Flag that turns Mercy on for other PCs, but not NPCs?
Nah.
I dig this one. What if you start a spar in the wrong area of the place? The guards should have mercy on you and they can -maybe- report that your higher rank person. Or is it there other way around? Then, I say no.
EDIT: I read it wrong, but that's my view.
I say no because while I understand the intent behind it, turning mercy on or off for PCs only is kind of like ignoring the NPCs around you while acknowledging the PCs. I'd rather that you were forced to remember that you had mercy on or off.
An addition to prompt stating that you had mercy on or off would be a grand idea, though.
I am in favour of this despite the fact that it goes against the general PCs=NPCs rule-of-thumb. It's a playability issue.
I could see it being a convenience issue, but I don't see why it's necessary.
If you forget mercy's on and you beat something down 'till mercy kicks in, they'd be quite too incapacitated to fight back.
A simple turning off of mercy and attacking your target once more solves that issue quite effectively.
No. Sounds too much like no PK hack and slash.