"Mick McCarthy has done a fantastic job but if we continued in this way we were definitely going to be relegated," said Wolves chief executive Jez Moxey.
"The trend was only going one way and when we lost 5-1 at home to West Brom we had to act," he added.
"This has been a decision we've taken with a heavy heart but we have to act in the best interests of the club," Moxey told Sky Sports News.
"We've had brilliant times with Mick McCarthy and it is sad it has come to an end. But I'm sure it won't be long before he's back in management.
McCarthy sacking not easy - Moxey
"We now have two weeks until our next game against Newcastle, which is enough time to find a new manager and turn our fortunes around."
McCarthy said: "I feel we've achieved a lot, both for me personally and as a club.
"I really feel it is a privilege to have managed such a great club and I've had the best of times.
"I want to send my best wishes to everybody and also to the new guy that comes in - and to everyone. Please stay up!"
Sunday's loss saw Wolves drop into the relegation zone on goal difference, having collected only 21 points from 25 games.
Some fans vented their anger towards the directors' box during the match and a couple of hundred demonstrated outside the ground long after the final whistle.
Charles Ross, editor of A Load Of Bull, a Wolves fanzine, agreed with the club's decision but questioned the timing.
"I'm not surprised by the board's decision given the scale, the enormity, the shock of yesterday's defeat, and the opponents, the context of the game, and when it came in the season. The worst possible set of circumstances all conspired yesterday, particularly the manner of the defeat. That hurt.
"But it's the wrong time to sack a manager," Ross told BBC Sport. "He should have gone in the early autumn when they started on a bad run and you could see the wheels were coming off."
Club owner Steve Morgan, who is on a skiing holiday, decided to act 13 games before the end of the Premier League campaign.
With Wolves not involved in the FA Cup next weekend, they do not play until the trip to Newcastle on 25 February, with bookmakers making former Liverpool boss Rafael Benitez and ex-West Ham United manager Alan Curbishley favourites to replace McCarthy.
Pat MurphyRadio 5 live sports reporter
"I thought they'd keep faith with Mick McCarthy until the end of the season. The chairman, Steve Morgan, is on a family holiday. He watched the game on television and I understand he was furious after the second-half capitulation. I thought they'd hang onto McCarthy, though, particularly as there aren't many candidates out there with experience of a relegation battle. I just wonder whether this is the right call from the chairman. I am surprised McCarthy's gone"
The club began the season by taking seven points from their opening three games, but a
2-0 home defeat by Tottenham
prompted an alarming slide.
2-1 win at QPR
on 4 February ended a run of 11 games without a win in all competitions but the West Brom loss was a fourth successive home defeat.
Former Wolves and England boss Graham Taylor told BBC 5 live: "Mick McCarthy has had a tremendous five-and-a-half years at Wolves. Steve Morgan, the chairman, probably feels they just need a positive change to get the number of points they need to stay up.
"Managers are responsible for results but players are responsible for their performances. I watched the game and a number of the Wolves players should be looking at themselves.
"A 5-1 defeat at home to West Brom? You'll do well to survive that."
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