The Ethernet protocol requires that a signal sent out over the LAN reach every part of the network within a specified length of time. The 5-4-3 rule ensures this. Each repeater that a signal goes through adds a small amount of time to the process, so the rule is designed to minimize transmission times of the signals.

The 5-4-3 rule -- which was created when Ethernet, 10Base5, and 10Base2 were the only types of Ethernet network available -- only applies to shared-access Ethernet backbones. A switched Ethernet network should be exempt from the 5-4-3 rule because each switch has a buffer to temporarily store data and all nodes can access a switched Ethernet LAN simultaneously.

Also see the Ethernet Designations chart in the Quick Reference section of Webopedia.

Large Networks: 5-4-3 rule
Diagrams of network setups.