This option creates the collision areas for the players and monsters.
Each object from your map (if its collision parameter is set true ) and the inaccessible areas (see also: inaccessible terrain tool) is checked for this action. From the bounding boxes of the objects and the inaccessible areas the no-go-area is computed.
You can preview the pathing in Editing mode by toggling 'View - Path mesh preview' from the menu.
As long as you have not created any pathing the player or your monsters cannot walk anywhere.
Player and monsters will be able to walk through items placed on the map after the last building of the pathing. Conversely, they will not be able to walk where an item has since been deleted.