I'm trying to find out why compress(1) uses .Z as filename extension.
My theory is that it was inspired by pack(1), which uses the .z extension.
I think that connection is plain. As for the .z extension, I'd guess (and it's nothing better than that, just a conclusion I jumped to long ago) that it makes compressed files sort after files that share the same root name.
IIRC, compress(1) used to be able to unpack files as well as uncompressing them. I don't know if that's still true.