When I add a path in the presets tab, I can add models that are in that folder using the WED Add Objects dialogue. If I try to use any models that are in a sub-directory however, WED gives me an error saying that it can't open the file.

For example, I add the path "models" in WED. When I add the model "pguard3.mdl" from the directory "models\palace-guard" and try to run my level, WED can't open it. It seems that the only way that WED can find the model file is if I add the sub-directory path. Do I have to add a path for every sub-directory?

i think you have to, but its not that hard, just add this:
PATH "foldername";

According to the manual, there is a 32 PATH names limit. Could that become a problem if every sub-directory must be added? Why is it that the WED Add Objects dialogue can read the models in the sub-directories but they cannot be found on run-time unless the path is explicitly set?

i don't think it's necesary to have 32 subfolders, I have one for levels, other for code, other for sounds, other for folders and another one for models

you can add 32 paths, but if you create models or images etc from script, you can tell to use these from the folder by writing "./pathfolder/file.ext".
This way you can use items from subfolders, without having to add the folder specifically...

Again, if it's for example a model dependant on a level, and both are in different folders, you have to add each of this folder. otherwise, non-dependant assets can be loaded like above.

regards,

Get this...
Why bother having paths at all...
When you publish, all the files get put into one folder...
Try doing that, then save your wed/wmb and wmp and wdl or
.c... whatever into the new compiled/published folder ...
Then you have a clean folder with only the required files...
Then review your file sizes and work to optimize by reducing file sizes such as retexture using .dds files...
This procedure works wonders...
Then script out those damb path statements and make sure you back-up... Pays to play it safe...
// (But, there is something to be said for keeping things tidy...)
// None-the-less, it's a wonderful way to work at optimizing...

It would be useful to still have a sub-directory structure in tact unless you wanted a mess of models in only one directory.

The mess that you refer to can have the icons arranged by "type" and then change the folder options to "details".
From there you can determine which files to optimize.
Of course you do not have to use that folder as your main construction folder.
Just simply use this concept to assist you in the optimization process.
Basically... these concepts are "food for thought"...