Leadership development research has largely drawn on experiential and enactive learning theories to explore the positive effects of developmental challenge on leaders. In contrast, we examined potential positive and negative effects of developmental challenge (i.e., challenging job assignments) on leader behavior through an alternative theoretical lens—transactional stress theory. We predicted, on one hand, that developmental challenge may be associated with higher leader engagement and transformational leadership behavior; however, developmental challenge also has the potential to be associated with higher leader emotional exhaustion and laissez-faire leadership behavior. We further proposed that leadership self-efficacy (LSE) moderates these potential effects of developmental challenge and helps explain why leaders react either positively or negatively to developmental challenge. We tested our hypotheses in a sample of 153 leaders and 631 direct reports at a Fortune 500 company. Findings supported positive relationships among developmental challenge, leader engagement, and transformational leadership. However, we also found support for significant relationships among developmental challenge, emotional exhaustion, and laissez-faire leadership. Additionally, leaders lower in LSE were more likely to encounter the negative effects of developmental challenge by experiencing increased emotional exhaustion and displaying laissez-faire leadership behaviors. Our study contributes to theory and practice by elucidating a “dark side” of developmental challenge, identifying LSE as a moderator of the negative effects of developmental challenge, identifying antecedents of transformational and laissez-faire leadership behaviors, and investigating demands and stress in leadership roles.