usually the valve shuts off the water to the tub faucet forcing the water up and out the shower. There is a small venturi the water goes through, but if that gets plugged the water stops, it is there to make the water go to the tub unless the water is stopped by the diverter, you could have the wrong stem, if it's not seating properly, did it ever work? If it did, then did you remove the seat the valve washer closes on? Maybe the seat fell apart. The three valve systems with washers are simple, the washer is not seating to stop the flow to the tub. It looks like the washer on the stem in the picture has never seated, it should have a small ring dented into it once it seats. I think that washer should be flatter instead of cone shaped.