Thanks.
One small update -- I have given absolute path in "start_service" definition and at least it moves ahead .. but now I am facing similar sort of problem in another area.
Below is my latest boot log


Starting kernel ...

[ 0.000000] Linux version 2.6.34.9-svn17134 (tatha@localhost.localdomain) (gcc version 4.1.2) #4 Mon Sep 12 13:59:40 IST 2011
[ 0.000000] bootconsole [early0] enabled
[ 0.000000] CPU revision is: 00019374 (MIPS 24Kc)
[ 0.000000] booting platform Atheros AR7161 rev 2 (0xaa)
[ 0.000000] Determined physical RAM map:
[ 0.000000] memory: 08000000 @ 00000000 (usable)
[ 0.000000] Zone PFN ranges:
[ 0.000000] Normal 0x00000000 -> 0x00008000
[ 0.000000] Movable zone start PFN for each node
[ 0.000000] early_node_map[1] active PFN ranges
[ 0.000000] 0: 0x00000000 -> 0x00008000
[ 0.000000] Built 1 zonelists in Zone order, mobility grouping on. Total pages: 32512
[ 0.000000] Kernel command line: console=ttyS0,115200 root=/dev/mtdblock2 rootfstype=squashfs init=/sbin/init
[ 0.000000] PID hash table entries: 512 (order: -1, 2048 bytes)
[ 0.000000] Dentry cache hash table entries: 16384 (order: 4, 65536 bytes)
[ 0.000000] Inode-cache hash table entries: 8192 (order: 3, 32768 bytes)
[ 0.000000] Primary instruction cache 64kB, VIPT, 4-way, linesize 32 bytes.
[ 0.000000] Primary data cache 32kB, 4-way, VIPT, cache aliases, linesize 32 bytes
[ 0.000000] Writing ErrCtl register=00000000
[ 0.000000] Readback ErrCtl register=00000000
[ 0.000000] Memory: 126644k/131072k available (2265k kernel code, 4428k reserved, 558k data, 148k init, 0k highmem)
[ 0.000000] NR_IRQS:128
[ 0.000000] irq init done
[ 0.000000] plat_time_init: plat time init done
[ 0.000000] Calibrating delay loop... 452.19 BogoMIPS (lpj=2260992)
[ 0.250000] Mount-cache hash table entries: 512
[ 0.250000] NET: Registered protocol family 16
[ 3.250000] registering PCI controller with io_map_base unset
[ 3.260000] bio: create slab at 0
[ 3.270000] usbcore: registered new interface driver usbfs
[ 3.270000] usbcore: registered new interface driver hub
[ 3.280000] usbcore: registered new device driver usb
[ 3.340000] no in flash calibration fata found, no fix required
[ 3.400000] no in flash calibration fata found, no fix required
[ 3.410000] pci 0000:00:00.0: BAR 0: assigned [mem 0x10000000-0x1000ffff]
[ 3.410000] pci 0000:00:00.0: BAR 0: set to [mem 0x10000000-0x1000ffff] (PCI address [0x10000000-0x1000ffff]
[ 3.420000] pci 0000:00:01.0: BAR 0: assigned [mem 0x10010000-0x1001ffff]
[ 3.420000] pci 0000:00:01.0: BAR 0: set to [mem 0x10010000-0x1001ffff] (PCI address [0x10010000-0x1001ffff]
[ 3.430000] fixup irq: got 48
[ 3.430000] fixup irq: got 49
[ 3.430000] Switching to clocksource MIPS
[ 3.440000] NET: Registered protocol family 2
[ 3.440000] IP route cache hash table entries: 1024 (order: 0, 4096 bytes)
[ 3.450000] TCP established hash table entries: 4096 (order: 3, 32768 bytes)
[ 3.460000] TCP bind hash table entries: 4096 (order: 2, 16384 bytes)
[ 3.460000] TCP: Hash tables configured (established 4096 bind 4096)
[ 3.470000] TCP reno registered
[ 3.470000] UDP hash table entries: 256 (order: 0, 4096 bytes)
[ 3.480000] UDP-Lite hash table entries: 256 (order: 0, 4096 bytes)
[ 3.480000] NET: Registered protocol family 1
[ 3.490000] gpio_proc: module loaded and /proc/gpio/ created
[ 3.490000] wl0gpio_proc: module loaded and /proc/wl0gpio/ created
[ 3.500000] AR7100 GPIOC major 0
[ 3.500000] init_vdso successfull
[ 3.510000] squashfs: version 3.0 (2006/03/15) Phillip Lougher
[ 3.510000] msgmni has been set to 247
[ 3.520000] io scheduler noop registered
[ 3.520000] io scheduler deadline registered (default)
[ 3.530000] Serial: 8250/16550 driver, 1 ports, IRQ sharing disabled
[ 3.530000] serial8250.0: ttyS0 at MMIO 0x18020000 (irq = 19) is a 16550A
[ 3.540000] console [ttyS0] enabled, bootconsole disabled
[ 3.540000] console [ttyS0] enabled, bootconsole disabled
[ 3.550000] guessed flashsize = 16M
[ 3.560000] scanning for root partition
[ 3.560000] bootloader size = 70000
[ 3.570000]
[ 3.570000] found squashfs at 170000
[ 3.580000] Creating 8 MTD partitions on "ar7100-nor0":
[ 3.580000] 0x000000000000-0x000000070000 : "RedBoot"
[ 3.590000] 0x000000070000-0x000001000000 : "linux"
[ 3.590000] 0x000000170000-0x000000430000 : "rootfs"
[ 3.600000] mtd: partition "rootfs" set to be root filesystem
[ 3.610000] 0x000000430000-0x000000fe0000 : "ddwrt"
[ 3.610000] 0x000000fe0000-0x000000ff0000 : "nvram"
[ 3.620000] 0x000000ff0000-0x000001000000 : "FIS directory"
[ 3.620000] 0x000000ff0000-0x000001000000 : "board_config"
[ 3.630000] 0x000000000000-0x000001000000 : "fullflash"
[ 3.640000] PPP generic driver version 2.4.2
[ 3.640000] PPP Deflate Compression module registered
[ 3.650000] PPP BSD Compression module registered
[ 3.650000] PPP MPPE Compression module registered
[ 3.660000] NET: Registered protocol family 24
[ 3.660000] PPPoL2TP kernel driver, V1.0
[ 3.660000] IMQ driver loaded successfully.
[ 3.670000] Hooking IMQ before NAT on PREROUTING.
[ 3.670000] Hooking IMQ after NAT on POSTROUTING.
[ 3.680000] tun: Universal TUN/TAP device driver, 1.6
[ 3.680000] tun: (C) 1999-2004 Max Krasnyansky
[ 3.690000] ehci_hcd: USB 2.0 'Enhanced' Host Controller (EHCI) Driver
[ 5.590000] ar71xx-ehci ar71xx-ehci.0: Atheros AR71xx built-in EHCI controller
[ 5.600000] ar71xx-ehci ar71xx-ehci.0: new USB bus registered, assigned bus number 1
[ 5.640000] ar71xx-ehci ar71xx-ehci.0: irq 3, io mem 0x1b000000
[ 5.660000] ar71xx-ehci ar71xx-ehci.0: USB 2.0 started, EHCI 1.00
[ 5.660000] usb usb1: New USB device found, idVendor=1d6b, idProduct=0002
[ 5.670000] usb usb1: New USB device strings: Mfr=3, Product=2, SerialNumber=1
[ 5.680000] usb usb1: Product: Atheros AR71xx built-in EHCI controller
[ 5.680000] usb usb1: Manufacturer: Linux 2.6.34.9-svn17134 ehci_hcd
[ 5.690000] usb usb1: SerialNumber: platform
[ 5.690000] hub 1-0:1.0: USB hub found
[ 5.700000] hub 1-0:1.0: 2 ports detected
[ 5.700000] ohci_hcd: USB 1.1 'Open' Host Controller (OHCI) Driver
[ 5.710000] ar71xx-ohci ar71xx-ohci.0: Atheros AR71xx built-in OHCI controller
[ 5.720000] ar71xx-ohci ar71xx-ohci.0: new USB bus registered, assigned bus number 2
[ 5.720000] ar71xx-ohci ar71xx-ohci.0: irq 22, io mem 0x1c000000
[ 5.790000] usb usb2: New USB device found, idVendor=1d6b, idProduct=0001
[ 5.800000] usb usb2: New USB device strings: Mfr=3, Product=2, SerialNumber=1
[ 5.800000] usb usb2: Product: Atheros AR71xx built-in OHCI controller
[ 5.810000] usb usb2: Manufacturer: Linux 2.6.34.9-svn17134 ohci_hcd
[ 5.820000] usb usb2: SerialNumber: platform
[ 5.820000] hub 2-0:1.0: USB hub found
[ 5.820000] hub 2-0:1.0: 2 ports detected
[ 5.830000] usbcore: registered new interface driver usbserial
[ 5.840000] USB Serial support registered for generic
[ 5.840000] usbcore: registered new interface driver usbserial_generic
[ 5.850000] usbserial: USB Serial Driver core
[ 5.850000] USB Serial support registered for GSM modem (1-port)
[ 5.860000] usbcore: registered new interface driver option
[ 5.860000] option: v0.7.2:USB Driver for GSM modems
[ 5.870000] USB Serial support registered for pl2303
[ 5.870000] usbcore: registered new interface driver pl2303
[ 5.880000] pl2303: Prolific PL2303 USB to serial adaptor driver
[ 5.890000] USB Serial support registered for Sierra USB modem
[ 5.890000] usbcore: registered new interface driver sierra
[ 5.900000] sierra: v.1.7.16:USB Driver for Sierra Wireless USB modems
[ 5.900000] Software Watchdog Timer: 0.07 initialized. soft_noboot=0 soft_margin=60 sec (nowayout= 0)
[ 5.910000] u32 classifier
[ 5.920000] input device check on
[ 5.920000] Actions configured
[ 5.920000] Netfilter messages via NETLINK v0.30.
[ 5.930000] nf_conntrack version 0.5.0 (1978 buckets, 7912 max)
[ 5.930000] CONFIG_NF_CT_ACCT is deprecated and will be removed soon. Please use
[ 5.940000] nf_conntrack.acct=1 kernel parameter, acct=1 nf_conntrack module option or
[ 5.950000] sysctl net.netfilter.nf_conntrack_acct=1 to enable it.
[ 5.960000] nf_conntrack_rtsp v0.6.21 loading
[ 5.960000] nf_nat_rtsp v0.6.21 loading
[ 5.960000] ip_tables: (C) 2000-2006 Netfilter Core Team
[ 5.970000] IPP2P v0.8.2 loading
[ 5.970000] TCP bic registered
[ 5.980000] TCP cubic registered
[ 5.980000] TCP westwood registered
[ 5.980000] TCP highspeed registered
[ 5.990000] TCP hybla registered
[ 5.990000] TCP htcp registered
[ 5.990000] TCP vegas registered
[ 6.000000] TCP veno registered
[ 6.000000] TCP scalable registered
[ 6.000000] TCP lp registered
[ 6.010000] TCP yeah registered
[ 6.010000] TCP illinois registered
[ 6.010000] NET: Registered protocol family 17
[ 6.020000] 802.1Q VLAN Support v1.8 Ben Greear
[ 6.020000] All bugs added by David S. Miller
[ 6.060000] Broken NVRAM found, recovering it (Magic FFFFFFFF)
[ 6.070000] VFS: Mounted root (squashfs filesystem) readonly on device 31:2.
[ 6.080000] Freeing unused kernel memory: 148k freed
start service
starting Architecture code for pb42
system: /sbin/startservice devinit
[ 6.670000] Algorithmics/MIPS FPU Emulator v1.5
starting hotplug
done
system: /sbin/startservice sysinit
/dev/console: No such file or directory
system: /sbin/startservice drivers
system: /sbin/startservice nvram
system: /sbin/startservice restore_defaults
/sbin/startservice: can't resolve symbol 'glob'
/etc/preinit: line 24: nvram: Permission denied
/etc/preinit: line 24: nvram: Permission denied
/etc/preinit: line 24: nvram: Permission denied
/etc/preinit: line 24: nvram: Permission denied
/etc/preinit: line 29: nvram: Permission denied
/etc/preinit: line 29: nvram: Permission denied
/etc/preinit: line 29: nvram: Permission denied
/etc/preinit: line 29: nvram: Permission denied
/etc/preinit: line 35: nvram: Permission denied
/etc/preinit: line 35: nvram: Permission denied
/etc/preinit: line 35: nvram: Permission denied
/etc/preinit: line 35: nvram: Permission denied
/etc/preinit: line 44: nvram: Permission denied
/etc/preinit: line 44: nvram: Permission denied
/etc/preinit: line 44: nvram: Permission denied
/etc/preinit: line 44: nvram: Permission denied
/etc/preinit: line 44: nvram: Permission denied
/etc/preinit: line 44: nvram: Permission denied
/etc/preinit: line 49: nvram: Permission denied
/etc/preinit: line 49: nvram: Permission denied
/etc/preinit: line 49: nvram: Permission denied
/etc/preinit: line 58: nvram: Permission denied
/etc/preinit: line 58: nvram: Permission denied
/etc/preinit: line 58: nvram: Permission denied
/etc/preinit: line 58: nvram: Permission denied
/etc/preinit: line 58: nvram: Permission denied
/etc/preinit: line 61: nvram: Permission denied
/etc/preinit: line 62: nvram: Permission denied
/etc/preinit: line 63: nvram: Permission denied
/etc/preinit: line 66: can't create /proc/sys/net/ipv4/ip_conntrack_max: nonexistent directory
system: /bin/echo vegas > /proc/sys/net/ipv4/tcp_congestion_control
system: /sbin/startservice mkfiles
system: /bin/mkdir -p /var/spool
mkdir: cannot create directory '/': File exists
system: /bin/mkdir -p /var/spool/cron
mkdir: cannot create directory '/': File exists
system: /bin/mkdir -p /var/lock/subsys
mkdir: cannot create directory '/': File exists
system: /bin/mkdir -p /var/spool/cron/crontabs
mkdir: cannot create directory '/': File exists
system: /bin/touch /var/spool/cron/crontabs/root
touch: /var/spool/cron/crontabs/root: No such file or directory
system: /bin/mkdir -p /var/lib
mkdir: cannot create directory '/': File exists
system: /bin/mkdir -p /var/lib/misc
mkdir: cannot create directory '/': File exists
system: /bin/mkdir -p /var/tmp
mkdir: cannot create directory '/': File exists
system: /bin/mkdir -p /var/log
mkdir: cannot create directory '/': File exists
system: /bin/touch /var/log/messages
system: /bin/chmod 0777 /tmp
system: /sbin/stopservice httpd
/etc/preinit: line 7: nvram: Permission denied
/etc/preinit: line 24: nvram: Permission denied
/etc/preinit: line 24: nvram: Permission denied
/etc/preinit: line 24: nvram: Permission denied
/etc/preinit: line 24: nvram: Permission denied
/etc/preinit: line 29: nvram: Permission denied
/etc/preinit: line 29: nvram: Permission denied
/etc/preinit: line 29: nvram: Permission denied
/etc/preinit: line 29: nvram: Permission denied
/etc/preinit: line 35: nvram: Permission denied
/etc/preinit: line 35: nvram: Permission denied
/etc/preinit: line 35: nvram: Permission denied
/etc/preinit: line 35: nvram: Permission denied
/etc/preinit: line 44: nvram: Permission denied
/etc/preinit: line 44: nvram: Permission denied
/etc/preinit: line 44: nvram: Permission denied
/etc/preinit: line 44: nvram: Permission denied
/etc/preinit: line 44: nvram: Permission denied
/etc/preinit: line 44: nvram: Permission denied
/etc/preinit: line 49: nvram: Permission denied
/etc/preinit: line 49: nvram: Permission denied
/etc/preinit: line 49: nvram: Permission denied
/etc/preinit: line 58: nvram: Permission denied
/etc/preinit: line 58: nvram: Permission denied
/etc/preinit: line 58: nvram: Permission denied
/etc/preinit: line 58: nvram: Permission denied
/etc/preinit: line 58: nvram: Permission denied
/etc/preinit: line 61: nvram: Permission denied
/etc/preinit: line 62: nvram: Permission denied
/etc/preinit: line 63: nvram: Permission denied
/etc/preinit: line 66: can't create /proc/sys/net/ipv4/ip_conntrack_max: nonexistent directory
system: /bin/echo vegas > /proc/sys/net/ipv4/tcp_congestion_control
system: /sbin/startservice_f resetbutton
system: /sbin/startservice setup_vlans
system: /sbin/startservice wlconf
get_wl_instance doesnt return the right value 0
system: /sbin/startservice lan
system: echo 0 >/proc/sys/net/bridge/bridge-nf-call-arptables
sh: can't create /proc/sys/net/bridge/bridge-nf-call-arptables: nonexistent directory
system: echo 0 >/proc/sys/net/bridge/bridge-nf-call-ip6tables
sh: can't create /proc/sys/net/bridge/bridge-nf-call-ip6tables: nonexistent directory
system: echo 0 >/proc/sys/net/bridge/bridge-nf-call-iptables
sh: can't create /proc/sys/net/bridge/bridge-nf-call-iptables: nonexistent directory
nvram_commit(): failed
/dev/gpio/control: No such file or directory
/dev/gpio/in: No such file or directory
/dev/gpio/out: No such file or directory
/dev/gpio/outen: No such file or directory
/dev/gpio/control: No such file or directory
/dev/gpio/outen: No such file or directory
/dev/gpio/out: No such file or directory
get_wl_instance doesnt return the right value 0
nvram_commit(): failed
Write wireless mac fail : : No such device
/sbin/startservice: can't resolve symbol 'getBridgeMTU'
nvram_commit(): failed
system: /sbin/startservice wan_boot
Write WAN mac fail :
: No such file or directory
No such device
[ 7.990000] br0: starting userspace STP failed, starting kernel STP
nvram_commit(): failed
sh: cat: Permission denied
/dev/gpio/control: No such file or directory
/dev/gpio/in: No such file or directory
/dev/gpio/out: No such file or directory
/dev/gpio/outen: No such file or directory
/dev/gpio/control: No such file or directory
/dev/gpio/outen: No such file or directory
/dev/gpio/out: No such file or directory
/sbin/startservice: can't resolve symbol 'scandir'
system: /sbin/startservice_f ttraff
/dev/gpio/control: No such file or directory
/dev/gpio/in: No such file or directory
/dev/gpio/out: No such file or directory
/dev/gpio/outen: No such file or directory
/dev/gpio/control: No such file or directory
/dev/gpio/outen: No such file or directory
/dev/gpio/out: No such file or directory
system: /sbin/startservice radio_on
get_wl_instance doesnt return the right value 0
system: /sbin/startservice_f radio_timer
system: /sbin/startservice_f run_rc_startup
system: /sbin/startservice_f modules
/etc/init.d/rcS: line 4: logger: Permission denied
/etc/init.d/rcS: line 4: can't open /dev/null
system: /sbin/startservice httpd
sh: can't open /dev/null
/sbin/startservice_f: can't resolve symbol 'scandir'
sh: cat: Permission denied
/sbin/startservices: can't resolve symbol 'scandir'

Yes, I used .config_wndr3700v2.
CONFIG_SYSFS is set but I could not find any parameter like CONFIG_DEVFS_FS.

I am using Linux-2.6.34.6. There I cannot find such entry in .config_wndr3700 and .config_wndr3700v2. Can this create such problem that I am facing now ?

I am able to get shell prompt.

I have found that permission of each executable are almost ?-w---x--x and it is clear to me why shell is showing error message "permission denied".
I have checked permission set of all executables in dd-wrt/src/router/mips-uclibc/target/ and they are fine.
But now my question is who is modifying this permission set ?

Yes, I also saw that. But other distribution also using same command and there I am not facing similar sort of problem.
And I have observed that squashfs code in DD-WRT is different than Tomato or OpenWRT. So this might causing the problem.