Path Data File?

[ColdSteel]

Can someone tell me how the path.txt file is used? If you open it up it says:

"This file must be located with the executable to tell it which directories to look in. If you make your own data sets, you should install them in a new directory, and then modify this file to set the location".

Then it has this line:
Data Directory := Data

This sounds like you can put a mod like the EA race and modded AI files for it in a directory and set the path here in the path.txt to look for them rather than the default files. Yet everyone here keeps talking about overwriting the default files with mods. Which is correct and what does this file do? Does anyone have an example of what the Data Directory line should look like? This is kind of confusing.

Thanks.