McCarthy, 53, was appointed Wolves manager in July 2006, winning promotion to the Premier League in 2009 but has lost his job following Wolves' fourth successive home league defeat.
In a statement on their website, the club said it was "a difficult decision to terminate Mick's contract" but that assistant Terry Connor would take charge of training until a new manager is appointed.
Sunday's defeat means Wolves have picked up only one point from their last six home matches and have won only once in their last 13 in all competitions.
McCarthy apologised afterwards to Wolves fans, many of whom protested by the statue of Billy Wright, who skippered them to three League titles in their 1950s heyday.
McCarthy said on Sunday: "I would say this is my most difficult day as a manager. I have apologised for the performance and I have never done that before.
"But I feel it is warranted - we were awful in the last half an hour. We capitulated which is not something associated with me or my teams. It was very disappointing."
Wolves, one of England's top clubs in the 1950s, winning the title in 1954, 1958 and 1959, later fell as low as the fourth division in the late 1980s before climbing back to the top.
They had one season in the Premier League in 2003/04 before returning to the second tier until McCarthy took them back in 2009. They started this season well, winning their opening two games but have won only three league matches since then.
Their last victory was the 2-1 win at Queens Park Rangers on February 4 which McCarthy described as the result to kickstart their revival, but sadly for him that optimism was crushed by West Brom, their fiercest local rivals.
McCarthy, who previously managed Millwall, Ireland and Sunderland, was the third Premier League manager to part company with his club this season following Steve Bruce at Sunderland and Neil Warnock at QPR.
Bookmakers have made former Liverpool boss Rafa Benitez and ex-West Ham United manager Alan Curbishley favourites to replace McCarthy.
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