This is a common error message that appears during IIS deployment failures. It is especially common with IIS 6.0. We suspect that this is another case of authentication and/or security problems.
We'd troubleshoot this problem the same way we did with our initial deplayment. Start with the simple case. Don't use a "Log" file or loose ibconfig file. Check for a NAT on server: not configuring the NAT is probably the number one cause of this error message.
Is this a Windows 2003 Server? If so, reread Josh's documents. Use SQL Server password if possible. IIS 6.0 uses NETWORK_USER, not ASP.NET as default Windows account. Check permissions on Virtual Directory.
After discovering that the problem only occurred using log directory and Windows Authentication, we suggested:
Sorry about the trouble with the log directory. Using Windows Authentication, the "user" account aliased by IIS 6.0 is no longer the "Network Service" account. IIS uses whichever Windows account that gets authenticated. So, you will need to grant NTFS "write" permissions to the "Users" group on the log folder. By default, the "Users" group only has read.
Therefore, depending on which IIS authentication you use: Anonymous or Windows Integrated, you would grant NTFS write permissions on the log folder to either the Network Service user account or the Users group. You could just grant write permissions for both if you want to easily switch from each authentication type.
We added the Windows account used for impersonation to the local "Users" group. We then added the "Users" group to the log folder permissions with Modify rights.