[ghaff]

Yes, almost everyone does this. It's just opaque in most cases. I will say that, assuming they follow their adjustments literally, you do have some odd situations. Your ideal strategy to maximize comp vs. cost of living is to live in a state where the comp for the whole state is set by a relatively high CoL city but to live in a lower cost area in that state. (At least that was the case last time I looked.)

[ADDED: Although it looks as if they've made their calculator more granular so that high CoL city doesn't carry over to other areas as much.]