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.]
Given how rare this is, we probably should praise them for the transparency.
Because what we are doing here is the very reason companies are not transparent in the first place: you never get praises, only critics.