Reading literary fiction might be more beneficial for fostering social-cognitive skills (i.e., theory of mind and empathy) than reading popular fiction. However, the superiority of literary fiction might be complex and depend on readers' narrative engagement, transportation, and identification. To answer this research question, we conducted an experiment, in which 262 adult participants read either a literary story or a popular story. Afterward participants' perception of the story (literary quality, stimulation of reflection, influence on own life and attitudes), their narrative engagement, transportation, and identification, as well as their theory-of-mind performance and self-reported empathy were assessed. We found that readers judged literary fiction to be of higher quality, to stimulate more (self-)reflection, to be of higher relevance to their lives, and to be more narratively engaging and transporting than popular fiction. Although literary and popular stories did not affect self-reported empathy and theory-of-mind performance differentially, readers' narrative engagement, transportation, and identification moderated the effect of story condition on theory of mind. Readers of literary stories who were strongly engaged and transported into the stories and who strongly identified with its characters showed a better theory-of-mind performance than readers of popular stories. Our findings underline the importance of narrative processes for understanding social-cognitive story effects.