I don't know if this answer can help you, but I found this information - most probably you already know it but I'm pasting it here anyway, who knows?
It says that this preference is not working when you're using Visual Studio built-in web server (as most developers does) and NOT IIS.
"NOTE: The approaches suggested in this article will not work when you're using the built-in VS 2005 web server. They will only work when your site is running in IIS because the VS 2005 internal server does not support virtual directories. If you are testing locally (and not using IIS), you must have a copy of the RadControls folder in your web application."
The note has been taken from here and it's about VS2005:
EDIT 1: moreover, it's working when the UseEmbeddedScripts property of the control is set to false, so it's not your case. Well, I hope it's useful anyway.
EDIT 2: I found another link that could help to better find a solution. As @cahmadzadeh said, those are Http Handlers and they're most probably managed outside Telerik: